Joel Greenblatt's Timeless Advice to Finding Value

In his MasterClass video “Find Hidden Value in Lesser-Known Places“, Joel Greenblatt discusses his evolution as an investor from a simplistic strategy of buying cheap stocks to a more nuanced approach to buying good businesses at bargain prices. Greenblatt emphasizes the investing principles he’s learned as a Benjamin Graham and Warren Buffett student. Having a process, understanding what drives business value, concentrating in your circle of competence, and learning from mistakes are all essential characteristics of a successful investor.

Table of Contents

5 Key Takeaways from Joel Greenblatt’s MasterClass:

Focus on valuation and what a business is intrinsically worth. A margin of safety is critical, so buy at a discount to that value.
Combine value and quality and buy good businesses cheaply. Growth and value investing are interconnected.
Develop a sound process based on fundamentals and stick to it with discipline, even when it temporarily underperforms.
Stay patient. The market will eventually recognize value, but the timing is unpredictable. Endure short-term pain for long-term gain.
Concentrate investments in your circle of competence where you have an informational edge. Continuously learn and evolve your approach.

Who is Joel Greenblatt?

Joel Greenblatt has cultivated a reputation as one of this generation’s most astute value investors. As co-chief investment officer of Gotham Asset Management, Greenblatt has amassed an enviable track record over the past few decades.

He first delved into value investing while studying at the Wharton School in the late 1970s, where he was introduced to the writings of Benjamin Graham. Greenblatt was puzzled by the efficient market hypothesis taught by his professors, finding it at odds with the notion that stocks could become mispriced. This led him to launch his hedge fund, Gotham Capital, in 1985.

Beyond his investing acumen, Greenblatt is also known for his generosity in sharing wisdom. He teaches a popular value investing class at Columbia Business School and has authored several books explaining his analytical framework in accessible terms. When Greenblatt speaks, wise investors listen.

Who is Mr. Market?

Throughout the MasterClass, Joel Greenblatt frequently references Benjamin Graham’s metaphor of Mr. Market to illustrate a key facet of investing psychology.

As Greenblatt explains, “Mr. Market is your partner in a business. Sometimes he wakes up happy and is willing to pay you a lot for your partnership interest. Sometimes he wakes up sad and is willing to sell his interest at a very low price.”

Mr. Market represents the emotional swings of the stock market between optimism and pessimism, greed and fear. Whereas the intrinsic value of a business changes gradually over time, Mr. Market’s quotational value fluctuates wildly based on sentiment. This disconnect between price and value presents lucrative opportunities for disciplined investors like Greenblatt.

When Mr. Market is euphoric and values are stretched, Greenblatt recommends selling. Conversely, when Mr. Market is despondent, Greenblatt counsels buying good businesses at bargain prices. Mr. Market grants long-term investors this latitude.

Learning from Mistakes: How Setbacks Strengthened Joel Greenblatt’s Approach

In his early days of investing, Greenblatt made mistakes that imparted important lessons. After losing a substantial amount on a series of merger arbitrage investments, Greenblatt realized he had underestimated concentration risk. This taught him to rigorously assess portfolio interdependencies and downside risks. Greenblatt also weathered a frustrating period in the late 1990s when his value-focused strategy significantly underperformed the booming technology stocks. This tested his conviction, but sticking to a proven process was rewarded.

As Greenblatt reflects, “It doesn’t feel good when the market disagrees with you. You have to believe that your process makes sense and the market will recognize value eventually.” Greenblatt stresses reviewing decisions to improve. He also became more conservative after early setbacks, sizing positions to limit potential losses. In this way, mistakes paved the road to future success.

Joel Greenblatt on the Subtle Art of Value Investing

While far from easy, Greenblatt views investing as surmountable with experience, skill, and discipline. He states, “Part of investing is an art or craft that comes with experience. Part is having good fundamentals and a plan to evaluate opportunities.” Greenblatt learned foundational value principles from predecessors like Graham, who stressed valuation and margins of safety.

However, Greenblatt’s evolution shows value investing also has nuance. For example, he realized cheap, low-quality stocks offered less assurance than stable, financially sound companies. His magic formula retains Graham’s central belief – buying below intrinsic value – while also screening for quality metrics like high returns on capital. Greenblatt recommends combining quantitative and qualitative tools, concentrated bets in your circle of competence, and constantly striving to improve. For Greenblatt, the market’s inefficiencies almost guarantee rewards for those with patience, aptitude, and diligence.

Why Patience Is Paramount According to Joel Greenblatt

Given the volatility of stocks, cultivating patience represents one of the greatest challenges in investing – and one of the greatest edges. Joel Greenblatt advises, “Patience will be the last man standing.” Why? Because investing revolves around taking a long-term view rather than reacting to daily market gyrations.

Greenblatt explains, “If you can keep a long time horizon and not worry about the short term, that’s rare.” Patience permits exploiting fear and greed without getting unsettled by uncertainty. Greenblatt weathered short-term underperformance before his thesis was finally rewarded. Adopting a multi-year horizon can confer similar advantages. Greenblatt believes staying disciplined through ups and downs enables capturing the profit potential when undervalued assets finally converge to fair value.

Tying Growth and Value Investing Together

In Joel Greenblatt’s view, “Growth and value investing are tied at the hip.” He rejects the idea of treating them as discrete philosophies, explaining, “Growth is a component of value.” His magic formula exemplifies this linkage, screening for value metrics like earnings yield alongside quality indicators like return on capital. This capitalizes on Mr. Market occasionally mispricing growth stocks.

Greenblatt states, “Good and cheap worked best together.” Though deceptively simple, buying above-average businesses at below-average prices delivers outperformance. Greenblatt believes analyzing future earnings power is integral to determining intrinsic value. He evolved from buying statistically cheap stocks to more nuanced appreciation that profitable growth enriches value. His magic formula distills Greenblatt’s synthesis of growth and value investing into a straightforward, lucrative strategy.

Joel Greenblatt on Learning from Investment Giants Warren Buffett and Benjamin Graham

Greenblatt draws heavily from legendary investors Benjamin Graham and Warren Buffett. Graham pioneered value investing with concepts like margin of safety. Greenblatt describes how Graham’s Mr. Market allegory “really rang a bell and set off a light bulb.” Meanwhile, Buffett built on Graham’s foundation by also emphasizing high-quality companies. Greenblatt blended their approaches when formulating his magic formula.

But perhaps Greenblatt’s greatest takeaway regards temperament. Buffett and Graham exemplified rationality in the face of market manias and panics. Their calm analysis exploits others’ emotionality. Greenblatt observes that today’s market remains prone to the same mood swings. For patient investors who can tune out noise and stick to first principles, this creates the potential for continued outperformance.

The Enduring Sage Wisdom of Value Investing

While markets and tactics evolve, Joel Greenblatt believes the essence of value investing remains unchanged. He continues to stress basics like valuation, margin of safety, patience, concentration, and risk control. Greenblatt observes that these principles conferred an edge for Graham and Buffett decades ago and still represent the best practices today. Investing success requires following Greenblatt’s maxim to “figure out what a business is worth, and pay a lot less.” Of course, Greenblatt recognizes investors also face new challenges like deciphering emerging technologies. Nevertheless, his fundamental and timeless advice offers guideposts to navigate the market’s ups and downs in pursuit of long-term profits.

How To Implement Joel Greenblatt’s Strategy

To apply Joel Greenblatt’s investing principles, here are some actionable and concrete steps:

Develop a sound process for identifying quality companies trading at discounts to intrinsic value. Use metrics like earnings yield and return on capital as initial screens.
Perform rigorous due diligence on shortlisted stocks. Gather information from 10-Ks, listen to earnings calls, and analyze competitors.
Construct a concentrated portfolio of high-conviction opportunities within your circle of competence. Size positions using upside-downside analysis.
Use patience and discipline. Endure short-term underperformance by sticking to your process. Let winners run.
Continuously evolve your approach by studying previous mistakes and expanding your analytical skills.

We also recommend income investing strategies that complement a portfolio’s value stocks. Earning yield on cash through low-risk options like brokered CDs, Treasury bills (one of Buffett’s favorite investments), money market funds, and ultra short bond ETFs can boost your portfolio’s returns.