Speaker 1: This is Masters in Business with Barry Ridholts on Bloomberg
Speaker 1: Radio this weekend on the podcast What Can I Say?
Speaker 1: Joel Greenblack he is Wall Street Royalty. He's a legend
Speaker 1: in the hedge fund and mutual fund world. He ran
Speaker 1: a fund called Gotham Capital ten consecutive years, compounding at
Speaker 1: fifty percent a year. Those numbers are just off the charts.
Speaker 1: At the end of the decade, he returned money backed
Speaker 1: investors and said, I'm gonna just manage my own money
Speaker 1: for a while. Thanks. Fourteen years later, he opens the
Speaker 1: mutual funds Gotham Asset Management. His index plus was just
Speaker 1: rated the number one fund out of large cap mutual funds. Uh.
Speaker 1: Just astonishing astonishing numbers. That that fund is only three
Speaker 1: years old. It acts as a hedge fund alternative. You
Speaker 1: probably know the name Joel Greenblack from his books. He
Speaker 1: tells the story of why you two can be a
Speaker 1: stock market Genius was a terrible and accidental title, as
Speaker 1: well as The Little Book that Beats the Stock Market,
Speaker 1: The Magic Formula. I'm gonna just shut up and say,
Speaker 1: with no further ado, A fascinating conversation with Joel Greenblack.
Speaker 1: I'm Barry Ridholtz. You're listening to Masters in Business on
Speaker 1: Bloomberg Radio. My extra special guest this week is Joel Greenblatt.
Speaker 1: He is the managing principal and co chief Investment Officer
Speaker 1: of Gotham Asset Management, the successor to Gotham Capital in
Speaker 1: a manner of speaking. He's also an adjunct professor at
Speaker 1: Columbia Business School, where he teaches value and special situation investing.
Speaker 1: He is the author of numerous well selling books, best
Speaker 1: selling books You Can Be a Stock Market Genius, The
Speaker 1: Little Book that Beats the Market, The Big Secret for
Speaker 1: the Small Investor. Joel green Black, Welcome to Bloomberg Ranks.
Speaker 1: So I'm excited to us speak to you. I very
Speaker 1: vividly remember when You Can Be a Stock Market Genius
Speaker 1: came out uh in the late nineties and exploded. It
Speaker 1: was sort of out of left field, at least to me,
Speaker 1: and just was suddenly a really really big book. But
Speaker 1: let's let's go back and start um early. So I
Speaker 1: have to ask the question from you Can Be Stock
Speaker 1: Market Genius, what did going to the Dog Track teach
Speaker 1: you about investing? Well? I wrote up in the book
Speaker 1: that you know, the only place when I was younger,
Speaker 1: I kind of like gambling, and the only place that
Speaker 1: would let to sneak in was the dog track when
Speaker 1: I was on vacation in Florida, and so I used
Speaker 1: to sneak in with my cousin and we uh got
Speaker 1: to place bets and have a good time, and you know,
Speaker 1: half the fun was sneaking in. But uh, we figured
Speaker 1: we really had the whole dog track thing nailed when
Speaker 1: we found a dog that had run uh it's last
Speaker 1: race in thirty two seconds and all the other dogs
Speaker 1: had run it in forty four seconds. And we thought, wow,
Speaker 1: you know, we really have a great dog going to
Speaker 1: bet on this thing. What were the odds? Oh, we had,
Speaker 1: you know, very high odds. It was close to I think,
Speaker 1: which I think is as high as they let it go.
Speaker 1: And so we thought we were going to clean up. Uh,
Speaker 1: and of course we lost. You know, that dog had
Speaker 1: been running a shorter race. That's why it only ran
Speaker 1: thirty two seconds. And so you sort of really have
Speaker 1: to know something when you're betting, and and the same
Speaker 1: thing for investing. You know, if you don't know what
Speaker 1: you're doing, Uh, it's and you know, as they say,
Speaker 1: an expensive place to find out so the dog track,
Speaker 1: I think was a nice lesson losing you know, two
Speaker 1: or four dollars. Uh, it was a very cheap lesson
Speaker 1: for us. So you go to school at Wharton, both
Speaker 1: undergrad and graduate. How did you find your way to
Speaker 1: Wall Street? What was your first job like? Uh, well,
Speaker 1: I got a summer job on Wall Street first, a
Speaker 1: kuder people in their research department. And to tell you
Speaker 1: how long ago it was, uh, we were adjusting financial
Speaker 1: statements for inflation, which doesn't probably wouldn't be a big
Speaker 1: seller right now, but for the younger listeners, tell us,
Speaker 1: what is this inflation you speak of? Well, you know
Speaker 1: when you hold your dollars and it buys less and
Speaker 1: less each year, but less and less was like six
Speaker 1: or eight percent, not uh, you know, half a percent
Speaker 1: or one percent or what we've become used to in
Speaker 1: the last ten years or so. And and what led
Speaker 1: you from research into the art of stock picking? Well,
Speaker 1: junior year, I read an article actually Informs magazine about
Speaker 1: Ben Graham's stock picking uh formula, and it was really
Speaker 1: what they used to call net nets or stock selling
Speaker 1: below their liquidation value. And it seemed very simple to
Speaker 1: me because I was at Wardant at the time, and
Speaker 1: they were learning uh, efficient market theory. Uh, and none
Speaker 1: of it reson it did with me. I was kind of,
Speaker 1: like I said, interested in gambling, or at least back
Speaker 1: speculating or figuring things out and then taking a calculated gamble. Uh.
Speaker 1: And what they were telling me was don't try. They
Speaker 1: were saying that no one can beat the market, and
Speaker 1: the stock prices are efficient and just through simple observation
Speaker 1: looking at the newspaper and then used to have the
Speaker 1: fifty two week Hilo prices in the newspaper. It seemed
Speaker 1: unreasonable that, you know, the fair price was fifty one
Speaker 1: day and eight months later it was a uh. And
Speaker 1: that was pretty much every stock had that kind of
Speaker 1: range every year. And it didn't make sense to me
Speaker 1: that the fundamentals of the underlying businesses were actually changing
Speaker 1: that much. And so when I read Ben Graham, sort
Speaker 1: of a lightbulb went off just this little article. Then
Speaker 1: I started reading everything I could about what he had written,
Speaker 1: both Security Analysis and The Intelligent Investor, and eventually led
Speaker 1: my way to Warren Buffett, and uh, you know, sort
Speaker 1: of the rest is history. It's a very good age.
Speaker 1: You know. I was younger than twenty one at the time,
Speaker 1: you know, junior year of of college, to recognize that
Speaker 1: this was what I was going to be doing the
Speaker 1: rest of my life. So let's talk a little about
Speaker 1: value investing. Since you mentioned Graham and Buffett, value has
Speaker 1: had a pretty rough go of it the past decade,
Speaker 1: very reminiscent of a similar period of rough performance in
Speaker 1: the nineties. For those of us with a value tilt
Speaker 1: in our portfolios, explain why this is a cyclical phenomena
Speaker 1: and not the death of value investing. Right. Well, my
Speaker 1: definition of value is figure out what the business is
Speaker 1: worth and pay a lot less. It is not low
Speaker 1: price to book, low price sales investing. Which if you
Speaker 1: took a look at morning Star, you took a look
Speaker 1: at Russell and and they analyze what we do. They
Speaker 1: don't put us in value as value investors. They put
Speaker 1: us in blend. As Warren Buffett would say, value and
Speaker 1: growth are tied at the hip. Growth is part of value.
Speaker 1: So the way that it's traditionally on uh you know
Speaker 1: now and categorized is not my definition of value. So
Speaker 1: what traditionally when people characterize these things low price book,
Speaker 1: low price sales, those are things that have correlated well
Speaker 1: in the past with higher returns cyclically, but over time
Speaker 1: it tends to work because let's say low price book uh,
Speaker 1: you know, something selling it uh close to its book value. Well,
Speaker 1: that just means people aren't giving a very high value
Speaker 1: to the business itself. They're just sort of valued pretty
Speaker 1: close to the cost of the assets that were placed
Speaker 1: in the business and not giving much of a premium.
Speaker 1: So you would tend to get more than your fair
Speaker 1: share of companies that are out of favor, meaning because
Speaker 1: they're price low. But if you are a private equity
Speaker 1: firm trying to buy a business, you're not buying it
Speaker 1: because it's trading close to its book value. You're looking
Speaker 1: at cash flows and trying to project what they're going
Speaker 1: to be in the future, and what are you paying
Speaker 1: relative to that and what's it worth. And that has
Speaker 1: nothing to do with low price book low low price sales.
Speaker 1: It really has to do with the cash flow generating
Speaker 1: part of the business. So you know, it does not
Speaker 1: bother me that traditional value as defined by morning Star
Speaker 1: Russell or whoever else defines it with sort of factor
Speaker 1: like attributes of individual stocks, has or has not worked.
Speaker 1: I mean, you know, here's the big thing the way
Speaker 1: I described as Look, momentum has worked well for the
Speaker 1: last thirty forty years, not just in this country, but
Speaker 1: across the globe, with one or two exceptions. The reason
Speaker 1: we don't we're not momentum investors, and there's no argument
Speaker 1: about it. It has. It's just that if it didn't
Speaker 1: work for the next two years, it could be that
Speaker 1: it's just cyclically out of favor, like we're talking about,
Speaker 1: and all we have to do is be patient and
Speaker 1: it works over the long term. You just have to
Speaker 1: be a patient investor. Or. It could be that it's
Speaker 1: you know, not so hard to figure out. A stock
Speaker 1: used to be down here and now it's out here,
Speaker 1: and there's plenty of data and computers and ability to
Speaker 1: crunch numbers, and plus plenty of research papers that say
Speaker 1: that momentums worked over a period of thirty forty years.
Speaker 1: And maybe if it doesn't work over the next two years,
Speaker 1: the trade has become crowded and it's degraded, and that's
Speaker 1: why it didn't work over the next two years. And
Speaker 1: two years from now, I wouldn't know whether it's just
Speaker 1: cyclically out of favor of the trades degraded so That's
Speaker 1: why I'm not a a momentum investor. The reason I'm
Speaker 1: a value investor. According to our definition is stocks are
Speaker 1: actually ownership shares of businesses that you value and try
Speaker 1: to buy it a discount. They're not pieces of paper
Speaker 1: that bounce around that you put sharp ratios and sortino
Speaker 1: ratios and a use computer simulations to balance your portfolios
Speaker 1: or whatever. It is. Basically, their ownership shares of businesses
Speaker 1: that you value and try to buy it a discount.
Speaker 1: So it's certainly possible that the market does not reward
Speaker 1: my valuations even if I'm right, over the next two years.
Speaker 1: But that doesn't mean we're gonna stop doing what we're doing.
Speaker 1: That's what stocks are ownership shares of businesses, and that's
Speaker 1: very fundamental to the way we look at everything. And
Speaker 1: if you actually look at them that way, you can
Speaker 1: see all of modern portfolio theory and all of the
Speaker 1: way most academics and many advisors and managers look at
Speaker 1: the world. It just seems kind of insane when you
Speaker 1: really boil it down to ownership shares of businesses that
Speaker 1: you're trying to value, and then you can really sift
Speaker 1: through all the confusion. Uh that very smart people have
Speaker 1: tried to uh put a lot of numbers on the
Speaker 1: investment business that don't make a lot of sense. That
Speaker 1: that's absolutely fascinated. Let's talk a little bit about Gotham Capital.
Speaker 1: You start with about seven million dollars, some of it
Speaker 1: coming from Michael Milkin. How did that relationship begin and
Speaker 1: why was Milkin interested in investing with you? Well, the
Speaker 1: simple story is that I had a friend at Wharton
Speaker 1: who was one of the first people, uh who was
Speaker 1: in Michael Milkin's group. And I had been working at
Speaker 1: a hedge fund for about three years after graduating from Wharton,
Speaker 1: and uh, I had always wanted to go out on
Speaker 1: my own, and I felt I was ready, and I
Speaker 1: mentioned it to my friend and I said, Gee, if
Speaker 1: I could raise you know, X dollars, I'd go out
Speaker 1: on my own. And UH, my good friend uh gave
Speaker 1: me a call the next day and said, Mike said fine, Yeah,
Speaker 1: So it wasn't It wasn't quite as easy as that.
Speaker 1: You know, I had to negotiate my terms and uh,
Speaker 1: it was actually kind of a funny story because it
Speaker 1: was my life and he did, you know, I don't
Speaker 1: know at the time. Twenty thirty deals a day. I
Speaker 1: have no idea, but it was my life. And I'm
Speaker 1: not a very good negotiating at all. But uh, when
Speaker 1: I was in the room with him, I wanted the
Speaker 1: terms that I wanted to to run the money because
Speaker 1: it was going to be my life and I only
Speaker 1: had one to give and this was one of thirty deals,
Speaker 1: and so I wouldn't give in. And we sat in
Speaker 1: there for an hour while he kept Ronald Perman waiting
Speaker 1: because he was about to buy Revlon. And you know,
Speaker 1: I was just like a little tiny deal and I
Speaker 1: wouldn't give in because you know, like I said, I
Speaker 1: had a bottom line, which is pretty rare. And he
Speaker 1: didn't let you walk. He negotiated like this was the
Speaker 1: biggest deal of his life, even though I knew it
Speaker 1: was just you know, something he did, you know, deserted
Speaker 1: lunch one day or something, and and uh he left
Speaker 1: the room and because I wouldn't give in, and he
Speaker 1: sent his brother in, and uh, you know, after half hour,
Speaker 1: I got the terms I wanted from his brother. And
Speaker 1: then when Mike got back, he was not very happy.
Speaker 1: But that's how I got into business. And uh, he
Speaker 1: was a good partner for me. That's a great story.
Speaker 1: So I have to share with our listeners your returns.
Speaker 1: You you compound from at annually before fees annually be
Speaker 1: four fees annually after fees five, No, it's fifty. For
Speaker 1: those ten years it was four fees. That's astounding. That's
Speaker 1: an incredible run of numbers. So the first question is
Speaker 1: what's the secret sauce? How you can We all know
Speaker 1: the eighties and nineties were a boomed time, but it
Speaker 1: wasn't fifty a year. What was the secret source for
Speaker 1: that sort of returns? Well, one of the ways to
Speaker 1: to get those kind of returns is not to run
Speaker 1: a lot of money. So after five years in business,
Speaker 1: we returned half our outside capital to investors. Yes they
Speaker 1: must have been thrilled. They were not thrilled, but after
Speaker 1: ten years returned all of it. That would make them
Speaker 1: really not thrilled because and the other way is to
Speaker 1: be concentrated. So sixty eight ideas were usually eighty plus
Speaker 1: percent of our portfolio. So that portfolio management theory doesn't
Speaker 1: like that strategy very much. Not diversified, higher risk, blah
Speaker 1: blah blah. Al Right, Well, Warren Bufett has a good
Speaker 1: response to that as well. You know, he says, Listen,
Speaker 1: let's say you sold out your business and you've got
Speaker 1: a million dollars and you're living in town, and you
Speaker 1: want to figure out something smart to do with it.
Speaker 1: So you analyze all the businesses and towns. Let's say
Speaker 1: there's hundreds of business and you stick to if you
Speaker 1: find businesses where the management is really good, the prospects
Speaker 1: for the business are good, it's run well, they treat
Speaker 1: older as well. And you divide your million dollars between
Speaker 1: eight businesses that you've researched well in town. No one
Speaker 1: would think that's imprudent. They'd actually think that would pretty prudent.
Speaker 1: But when you get to call them stocks, and you
Speaker 1: get stock quotes daily on these pieces of paper that
Speaker 1: bounce around and put people put numbers on it in
Speaker 1: volatility and all these other things, where really it's not
Speaker 1: that meaningful, you know. So in one sense, if you're
Speaker 1: investing in businesses and you did a lot of research
Speaker 1: and invested in eight different businesses with the proceeds of
Speaker 1: your sale, people would think you're a pretty prudent guy.
Speaker 1: All of a sudden. If you invested in stocks and
Speaker 1: did the same type of work, people think you're insane.
Speaker 1: And it's just an interesting analogy that I always think
Speaker 1: of when people make fun of me that I was
Speaker 1: that concentrated. You know. The flip side of that is,
Speaker 1: imagine if we got prints minute by minute for the
Speaker 1: valuation of our homes, people would lose their mind. They
Speaker 1: wouldn't be able to manage it. So that understood. Imagine
Speaker 1: if you had a theory of buying homes, I'm going
Speaker 1: to buy the ones that went up the most less
Speaker 1: three months or six months. I mean, it's a really
Speaker 1: good analogy. I usually use the house analogy when people
Speaker 1: ask me how do we go about and valuing stocks?
Speaker 1: And uh, people understand it completely when they're buying a house.
Speaker 1: There's certain things you would do and we don't do
Speaker 1: any different than owning a business. That makes a whole
Speaker 1: lot of sense. So now let me tack to what
Speaker 1: you're doing currently. So whereas you previously returned a bunch
Speaker 1: of money to investors and hedge funds and saying, hey,
Speaker 1: we we don't think there's this can scale enough that
Speaker 1: we can keep generating these returns for you, now you're
Speaker 1: you're going the opposite direction and saying okay, we're gonna
Speaker 1: look for something that can scale, So tell us a
Speaker 1: little bit about the Gotham Index plus portfolio. We were
Speaker 1: talking earlier offline about passive versus active. This is a
Speaker 1: little bit of both, right, So we didn't run outside
Speaker 1: money until again, after we returned it all in ninety four,
Speaker 1: we ran our interview. Had been lucky enough to keep
Speaker 1: our staff and run our internal money, but in and
Speaker 1: and how long did you do that? For fourteen years?
Speaker 1: And then uh, in two thousand nine we started taking
Speaker 1: outside money again. Uh. And it was really, you know,
Speaker 1: really starts really back when I was in business school
Speaker 1: and I had read that article about Benjamin Graham and
Speaker 1: actually did a study with a couple of my classmates,
Speaker 1: Rich Posina, who's a famous money manager now and uh
Speaker 1: Boost Newberg, who's still a good friend of mine, And
Speaker 1: we did some work on ben Graham's formulas, and we
Speaker 1: ended up doing a research paper and having it published
Speaker 1: in the Journal and Portfolio Management back in about one
Speaker 1: And I had always been fascinated by that, and over
Speaker 1: the years we had really evolved more towards the way
Speaker 1: Warren Buffett invests not just cheap, but cheap and good.
Speaker 1: And I've been teaching at Columbia for a number of years.
Speaker 1: I've been doing that twenty two years now, but you know,
Speaker 1: at that time, in the early two thousand's, Uh, i'd
Speaker 1: been doing it for a bunch of years, and we
Speaker 1: had been making money using the same principles Buffett uses,
Speaker 1: you know, buying cheap good businesses. And I wanted to
Speaker 1: prove that together with my partner Rob Goldstein, I wanted
Speaker 1: to prove that what I've been teaching my students, what
Speaker 1: we had been using to make money worked very well.
Speaker 1: Just like we had shown that Ben Graham's simple methodology
Speaker 1: still worked back in the seventies and early eighties, I
Speaker 1: wanted to show that what we had evolved more into
Speaker 1: the Warren Buffett way of earning money work too. We
Speaker 1: wanted to prove it in the same way that we
Speaker 1: had written that paper about. So we hired a computer
Speaker 1: analysts that could help us, you know, mind through data,
Speaker 1: and we came up with some very simple metrics for
Speaker 1: good you know what, what's a good business? And Uh,
Speaker 1: if you read through Buffet's letters, he's it's very clear
Speaker 1: he's looking for businesses that earn high returns on tangible
Speaker 1: capital um and what that means is every business needs
Speaker 1: working capital, every business needs fixed assets. How well can
Speaker 1: it convert that working capital and fixed assets into earnings?
Speaker 1: And in the book The Little Book that Beats the
Speaker 1: Market I, which I really wrote for my kids to
Speaker 1: understand this, I explained it this way. Imagine you're building
Speaker 1: a store and you have to buy the land, build
Speaker 1: the store, and set up the displays and stock it
Speaker 1: with inventory, and all that cost your four hundred thousand dollars.
Speaker 1: And every year, if the store earns two hundred thousand dollars,
Speaker 1: that's a fifty return untangible capital. Maybe I'll open some
Speaker 1: more stores. Then I compared it to another store, and
Speaker 1: I called that store just broccoli. It wasn't It's not
Speaker 1: a very good idea just to sell broccoli in your store.
Speaker 1: But you just have to buy the land, build the store,
Speaker 1: set of the display stock with inventory, still going to
Speaker 1: cost you roughly the four hundred thousand dollars. But because
Speaker 1: it's basically a stupid idea just to sell broccoli, maybe
Speaker 1: only earned ten thousand dollars. That's a two and a
Speaker 1: half percent return on tangible capital. And so all we
Speaker 1: said was all things being equal, much prefer to own
Speaker 1: the business, that business that can reinvest its money at
Speaker 1: fifty percent returns, then two and a half percent returns.
Speaker 1: So that was one metric good. That's what we looked at.
Speaker 1: If you read through Buffet's letters, that's the first thing
Speaker 1: he's looking for. Were The other metric we looked at
Speaker 1: is cheap. You know, in the analogy I would use
Speaker 1: as a house. You know, it's a million dollar house,
Speaker 1: and one question you might ask is how much rent
Speaker 1: could I get for that thing? And if you're trying
Speaker 1: to figure out whether that's a good deal or not.
Speaker 1: And if you could get eighty thousand dollars a year
Speaker 1: in rent, that's an eight percent yield in a two
Speaker 1: or three percent interest rate environment, that today might look
Speaker 1: fairly attractive. So we sort of looked at how much
Speaker 1: cash is the business generating relative to the all in
Speaker 1: cost of buying the business. Then we looked at whether
Speaker 1: it's a good business. When they have the money, what
Speaker 1: do they do with it? Okay, So we came up
Speaker 1: with two crude metrics for good and cheap. And you know,
Speaker 1: Ben Graham said, buy a cheap Warren Buffett said, if
Speaker 1: you could buy a good business cheap, even better we
Speaker 1: combined those two and uh we used a crude database,
Speaker 1: you know, simple database that was publicly available, well for
Speaker 1: a price. It was publicly available, and uh, we went
Speaker 1: and tested those two simple concepts, good and cheap. It's
Speaker 1: not like we spun the computer thousands of times. This
Speaker 1: was the very first test we did and it came
Speaker 1: out so phenomenally well that I wrote a book about it,
Speaker 1: called The Little Book that Beats the Market. That was
Speaker 1: the very first test we did. That's what I wrote up.
Speaker 1: But my partner, Rob Goldstein and I looked at each
Speaker 1: other and said, you know, I would call that the
Speaker 1: not trying very hard method. We actually know how to
Speaker 1: value businesses. You know, couldn't we It worked so well
Speaker 1: without trying. Couldn't we even improve on this? And so
Speaker 1: we built a big research team. You know, there's thirteen
Speaker 1: of us now we have a seven person tech team.
Speaker 1: And what we're really trying to do is just take
Speaker 1: advantage of that initial research and actually valuing businesses. And
Speaker 1: what we discovered was that and we're really building it
Speaker 1: for ourselves. You know, hey, can we do something with this.
Speaker 1: But it turned out that owning hundreds of names and
Speaker 1: being right on average was actually, Uh, we can make
Speaker 1: more money because we would have much less volatile returns.
Speaker 1: We'd have average. We get what we expect more often
Speaker 1: by owning hundreds and being right on average. And so
Speaker 1: it was very easy to put it together as a
Speaker 1: long short portfolio, buying our favorite cheapest stocks, shorting our
Speaker 1: most expensive and because we're doing hundreds, and because we're
Speaker 1: very good at valuing businesses on average okay, as opposed
Speaker 1: to having to be right on every single one when
Speaker 1: you're own six or eight. We turned out we made
Speaker 1: more money because we had spent less time getting negative
Speaker 1: returns with a diversified portfolio. When we discovered that we
Speaker 1: were willing to take outside money again, and this was
Speaker 1: back in March O nine. Is that we opened our
Speaker 1: first fund for institutions in March O nine. We are
Speaker 1: opened our first mutual fund in two thousand twelve. And
Speaker 1: we made some decisions back in two thousand nine. Number one,
Speaker 1: we said that most hedge fund managers, because we were
Speaker 1: long short investing with leverage, we're charging too much. I
Speaker 1: had said on Pen's investment board for ten years, us
Speaker 1: for ten years, and I saw most of the managers
Speaker 1: out there are not many justify one and a half
Speaker 1: and twenty or two and twenty. And the other part
Speaker 1: that's wrong with the hedge fund business is that when
Speaker 1: people pay those kind of prices, they're not very patient.
Speaker 1: So it's the worst of all worlds. You know, you're
Speaker 1: charging too much to your clients and they don't stay
Speaker 1: very long because they're, uh, they're impatient when they're they're
Speaker 1: paying so much. So we made two decisions. One is
Speaker 1: to you, uh, make our fees very reasonable, so we
Speaker 1: didn't have a performance fee. We just had, depending on
Speaker 1: the strategy, you know, maybe a two percent management fee
Speaker 1: with nothing else on a hedge fund as opposed to
Speaker 1: two and twenty. That was pretty uh novel at the time.
Speaker 1: And the other was that instead of locking people in
Speaker 1: for a year or two or three, we said, it's
Speaker 1: monthly liquidity. We don't want to run money for you
Speaker 1: if you don't want to be with us, and uh,
Speaker 1: thirty days is not a big gate these days at all. Right, Well,
Speaker 1: the idea really was is that when you give a
Speaker 1: gate every September October, people have to decide whether they
Speaker 1: want to lock up for another year or two. When
Speaker 1: you have monthly liquidity, you're never forcing them to make
Speaker 1: a decision maybe at a long time they can always
Speaker 1: have their money. And it's not a signaling device to
Speaker 1: say you should have a short time horizon. Actually for
Speaker 1: what we do, you need a long time horizon. But
Speaker 1: what it is is a comfort to know you could
Speaker 1: always have it and actually the money stick here. So
Speaker 1: we thought those were two things wrong with the hedge
Speaker 1: fund business. People took out it all the wrong times.
Speaker 1: They're charging too much, so we would leave our investors
Speaker 1: with more money and ability to have their money anytime.
Speaker 1: It was actually turned into be a very sticky business,
Speaker 1: and that's why three years later we were able to
Speaker 1: get into the mutual fund business not dilute our strategy
Speaker 1: because we were not charging exorbitant rates. We weren't charging
Speaker 1: a performance fee on our hedge funds, and so we
Speaker 1: were able to turn institutional quality hedge funds into mutual
Speaker 1: funds without diluting our strategy. If you're charging two and
Speaker 1: twenty two your or one and a half and twenty
Speaker 1: whatever it is to your investors, you can't move into
Speaker 1: the mutual fund space and just charge one and a
Speaker 1: half or two percent because without diluting your strategy, because
Speaker 1: your institutional investors would get upset. So what ended up
Speaker 1: happening is that we ended up going into the mutual
Speaker 1: fund area because we were charging very reasonable fees that
Speaker 1: would also work in the mutual fund area. But this
Speaker 1: is what we discovered, and this is my long winded
Speaker 1: way of answering your question, your very good question, how
Speaker 1: do we get into the Gotham index plus strategy, which
Speaker 1: is our new strategy. Well, it turns out, and we
Speaker 1: know this, but once we were able to come to
Speaker 1: registered investment advisors who talked to individual investors much more
Speaker 1: closely than institutionals, uh, institutional clients. The problem with active
Speaker 1: management in general is that to beat the market, you
Speaker 1: have to do something different than the market. High active
Speaker 1: share is, in the parlance of the industry, right, to
Speaker 1: beat the market, you have to do something different, but
Speaker 1: your returns as a result zig and zag differently. So
Speaker 1: I wrote a book called The Big Secret in two
Speaker 1: thousand eleven, and I still say it's a big secret
Speaker 1: because no one bought that or read that. Uh. So
Speaker 1: I'll just tell you about it. Uh. In it, I
Speaker 1: wrote up a few studies of remember I wrote in
Speaker 1: two thousand eleven. So I wrote up the decade two
Speaker 1: thousand to two thousand ten. This was a period where
Speaker 1: the market was flat, but the best performing mutual fund
Speaker 1: for that decade was up eighteen percent a year. It's
Speaker 1: just that the average investor in that fund managed to
Speaker 1: lose eleven percent a year on a dollar weighted basis
Speaker 1: by moving in and out at all the wrong times.
Speaker 1: So every time the market went up, people piled into
Speaker 1: that fund. When market went down, they piled out. When
Speaker 1: the fun outperformed, they piled in. When the fun underperformed,
Speaker 1: they piled out. And they took that eight percent annual
Speaker 1: game when the market was flat. So that's great on
Speaker 1: an annualized basis over ten year period to beat the
Speaker 1: market by eighteen points, But for outside investors, they went
Speaker 1: in and out so badly that the average investor on
Speaker 1: a dollar rated basis lost eleven percent a year. UH.
Speaker 1: And it's astonishing and and and it's typical, uh, even
Speaker 1: for institutions. I wrote up a study of institutional managers.
Speaker 1: So I took a look at the you know that study,
Speaker 1: which showed the top performing institutional managers for the same
Speaker 1: decade two thousand and two thousand ten, who ended up
Speaker 1: with the best ten year record quartile and what did
Speaker 1: that who ended up in the top quartel, and what
Speaker 1: did that look like? And that's what the study showed
Speaker 1: was that of those who ended up with the best
Speaker 1: tenure records spent at least three of those ten years
Speaker 1: in the bottom half of performance. Not shocking, but everyone
Speaker 1: because to beat the market you have to do something different.
Speaker 1: You're gonna have periods of outperformed under performance, and everyone did.
Speaker 1: Seventy of those who ended up with the best tenure
Speaker 1: records spent at least three of those ten years, at
Speaker 1: least three of the ten years in the bottom courtile
Speaker 1: of performance. And the one I love is that half
Speaker 1: they ended up with the best tenure record, but they
Speaker 1: spent at least three of those ten years in the
Speaker 1: bottom decile, the bottom performers. So you know, no one
Speaker 1: stayed with them, but that's how you end up with
Speaker 1: the best record. So here's a conundrum. There's a minority
Speaker 1: of active managers who beat the market, and it's best
Speaker 1: over a decade long, yes, and it's very hard to
Speaker 1: find them up front before they beat the market. And
Speaker 1: if you do, it's almost impossible to stick with them
Speaker 1: because to beat the market you have to do something
Speaker 1: different than the market. So, you know, picking active managers
Speaker 1: has been a loser's game for a long time, just
Speaker 1: even if there are some that win, and it's a minority.
Speaker 1: I agree, it's a minority. Uh. And so my partner
Speaker 1: Rob and I took a look at this problem, said,
Speaker 1: how can we solve this because part of the reason
Speaker 1: we're doing this we like making money. But if we're
Speaker 1: not making money for other people, which is uh, there
Speaker 1: really is not a lot of sense. And once we
Speaker 1: got into the mutual fund area, we wanted to help
Speaker 1: individual investors take advantage of the fact that we think
Speaker 1: we know what we're doing. So we developed something called
Speaker 1: Gotham Index Plus. So I was gonna say, West Gray
Speaker 1: of Alpha Architect, I don't know if you're familiar with
Speaker 1: his work, has a piece. I'm sure I'm mangling the
Speaker 1: UM title, but it's something along the lines even God
Speaker 1: would lose clients as an active manager, and I just
Speaker 1: find that hilarious. So what are you doing so differently
Speaker 1: with the index plus compared to what you were doing
Speaker 1: previously UM with special situations? And what did your research
Speaker 1: find about UM? How you could work around this problem
Speaker 1: of individuals under performing their own investments. Yeah, so it
Speaker 1: sounds almost like an impossible puzzle, but I'll tell you
Speaker 1: how we solved it. We said, number one, most people
Speaker 1: judge how they're doing, for better or worse, by seeing
Speaker 1: if they beat the SNP five that's in this country.
Speaker 1: And so we start at it there. We said, most
Speaker 1: people are gonna stick with things if it's beating the
Speaker 1: SNP five hundred, and lose if it's losing by too
Speaker 1: much to the SNP five hundred. So we started with
Speaker 1: that base for Gotham Index plus and we said, you
Speaker 1: give us a dollar, we're gonna buy the underlying stocks
Speaker 1: in the SNP five hundred. We're gonna put a dollar
Speaker 1: into that in the weights of the SNP five hundreds.
Speaker 1: So you give us a dollar. This is in mutual
Speaker 1: fund form. You give us a dollar, we recreate the
Speaker 1: SNP five hundred bottoms up and put a dollar into
Speaker 1: the SNP five hundred. Okay, that doesn't sound so hard
Speaker 1: to do, and don't think of ourselves as charging for
Speaker 1: that portion. That's pretty easy to do. And you're doing
Speaker 1: this not with indices but with actual and yes, we
Speaker 1: buy the individual stocks because as you'll hear in a moment.
Speaker 1: We're very very tax efficient, so it helps us to
Speaker 1: own the individual stocks. Then we go out and we
Speaker 1: buy ninety cents more of our favorite SMP stocks within
Speaker 1: the mutual fund. And how many are that is that
Speaker 1: second the plus part. What happens is we to the
Speaker 1: two D fifty out of the five hundred stocks in
Speaker 1: the sn P, five dred that we like the best.
Speaker 1: We adds more of those in the order in which
Speaker 1: we like them. So the more we like something, the
Speaker 1: more we'll add to it. Uh. And then we'll short
Speaker 1: or we'll sell nine cents worth of the stocks we
Speaker 1: like the least. So we have a ninety long nine
Speaker 1: short long short overlay on top of the dollar in
Speaker 1: the SNP. But we do some things to mitigate because
Speaker 1: obviously if we're gonna zig and zag too much, we
Speaker 1: want to have tracking error but positive tracking. Or people
Speaker 1: don't mind winning all the time, it's the losing part
Speaker 1: that they don't like. So we're trying to mitigate the
Speaker 1: losing parts. So what do we do. We're buying the
Speaker 1: cheapest stocks we can find and putting ninety cents into
Speaker 1: them in addition to the index. The dollar in the
Speaker 1: already in the index, and we're shorting ninety cents of
Speaker 1: our least favorite. But we want to balance that, so
Speaker 1: we have a zero beta on that because we already
Speaker 1: long a dollar in the market. We don't want to
Speaker 1: keep the same beta as the market. Number Two, we
Speaker 1: don't want to drive tracking or so we we don't
Speaker 1: want to small stock to drive returns. So something's let's
Speaker 1: say point one percent of the s and P five hundred.
Speaker 1: We don't want that driving our returns. But we may
Speaker 1: really like that stock. We may think it's really cheap,
Speaker 1: so we will buy more of it, and we may
Speaker 1: even buy five or eight times more of it, but
Speaker 1: that's only point oh five or point oh eight percent,
Speaker 1: not really going to drive returns. Will buy as much
Speaker 1: as we can, uh, subject to the constraints UH that
Speaker 1: we don't want to drive too much tracking error. The
Speaker 1: third thing we do is we balance fundamentals. In other words,
Speaker 1: the stocks were short of stocks trading at forty hundred
Speaker 1: times earnings. These are hope stocks. People really thinking they're
Speaker 1: buying them now, not on current earnings, but two thousand
Speaker 1: twenty two. They think it's gonna be really great, so
Speaker 1: they're buying these these are hope stocks based on the future.
Speaker 1: They're trading at forty fifty hundred UH times earnings, and
Speaker 1: but there are other reasons why people like them. Maybe
Speaker 1: sales are growing really quickly, or other aspects of the
Speaker 1: fundamentals are going well, so we balance those fundamentals. So
Speaker 1: if you took a look at our long portfolio, we
Speaker 1: have just as good sales growth in the cheap stocks
Speaker 1: were buying as the expensive stocks were shorting. So it's
Speaker 1: they're not unbalanced that way. You know the words, We're
Speaker 1: just getting them cheaper. They're cheaper, we're making comport. We're
Speaker 1: buying the cheapest stocks we can find. We're shorting the
Speaker 1: most expensive subject to constraints that keep us in line.
Speaker 1: One is there's a zero beta. Two is that small
Speaker 1: stocks won't drive returns. Three is that we balance fundamental
Speaker 1: So all we're doing is buying companies they are doing
Speaker 1: really well and we're just getting them cheaper. And UH
Speaker 1: as a result, we've been we just passed our three
Speaker 1: year anniversary and this fund UH we got five stars
Speaker 1: from morning Star. But more importantly, we beat all twelve
Speaker 1: funds in our category, which is March Capital and where
Speaker 1: the SNP is, and the most important part is is
Speaker 1: that we didn't do nearly as well as I hope
Speaker 1: to do in the next three years. UH. This was
Speaker 1: a very tough period for us. Even though we did
Speaker 1: very well relative to the other funds, we didn't do
Speaker 1: very well relative to our expectations. And the reason for
Speaker 1: that is because the market with you know, excluding the
Speaker 1: last two months, went straight up during those three years, UH,
Speaker 1: with no correct you have a big leverage short. We're
Speaker 1: short hope stocks the ninety cents. We're short our hope stocks.
Speaker 1: When you take risk in hope stocks and you get paid,
Speaker 1: then you take more risk, and you take more risk
Speaker 1: and there's no correction. So there's a very tough period
Speaker 1: for our short book. Luckily, our long book we're not
Speaker 1: low as I said before, we're not low price to
Speaker 1: book low price sales. Investors were cash flow oriented investors,
Speaker 1: and people get very optimistic about our cash flows and
Speaker 1: our businesses when things are going well. So our longs
Speaker 1: were able to keep pace with our shorts and even
Speaker 1: add three points a year to the UH to that
Speaker 1: and we so the plus long did better than the
Speaker 1: plus short and you still have the underlying SMP correct.
Speaker 1: So it's as index plus. But the great news is
Speaker 1: is that spread, that long short spread actually does better
Speaker 1: in bad markets. Well, that was my next questions with
Speaker 1: the words out of my mouth. If we would exceed,
Speaker 1: forget even another oh two thousand to oh two or
Speaker 1: eight oh nine, But I'm trying to think of a comparable.
Speaker 1: I was gonna say seventy three, seventy four, if that's
Speaker 1: not all that different from eight o nine. But if
Speaker 1: we see a run of the mill twenty correction that
Speaker 1: last eight months, how would you expect this to perform? Well,
Speaker 1: those are our best markets for our spread. So obviously
Speaker 1: the index portion wouldn't do all that well, but you
Speaker 1: would want we viewed as an index and your own protection,
Speaker 1: you know, the words for that portion of your portfolio.
Speaker 1: Want to be sixty net long if that's where your
Speaker 1: risk tolerance is. What's the smartest way to take that
Speaker 1: percent long allocations of the market of that forty or
Speaker 1: fifties sixty and so what we like about index plus
Speaker 1: it's really like owning the index with protection attached. Because
Speaker 1: you take high price cashing companies out our companies selling
Speaker 1: it a hundred times pretext FreeCast flow or fifty times,
Speaker 1: they're gonna take those guys out and shoot them. In
Speaker 1: bad markets, these are hope stocks. Those are gonna get crushed. Tesla,
Speaker 1: Netflix going down the whole, All those guys are gonna
Speaker 1: get crushed. You know. Uh, it turns out, you know,
Speaker 1: through all our research and everybody else, is that buying
Speaker 1: things that a hundred times earnings or things that are
Speaker 1: losing money is pretty much the world's worst strategy over time.
Speaker 1: And so in bad markets even worse than that, Uh,
Speaker 1: those stocks will get crushed. We're buying stocks that are
Speaker 1: have huge cash flows. People have low expectations for them.
Speaker 1: That's why we're getting them so cheap, and so we
Speaker 1: don't pay for high expectations in the long book. So
Speaker 1: when the lower bad news comes in, we didn't pay
Speaker 1: for high expectations. So our long stend to hold up better.
Speaker 1: Our shorts are getting killed. Great spreads and bad markets.
Speaker 1: And and let me just tell you where I think
Speaker 1: the market is. We value We have a big research team,
Speaker 1: and we value all the companies in the SMP five hundred.
Speaker 1: We also value the top roughly three thousand companies. But
Speaker 1: we value the these stocks in the SP five hundred.
Speaker 1: Every day for the last twenty eight years bottoms up,
Speaker 1: so I can contextualize where do we stand today relative
Speaker 1: to those twenty eight years, And right now we stand
Speaker 1: in the sixteenth percentile towards expensive over those twenty eight years,
Speaker 1: meaning the market has been cheaper percent of the time
Speaker 1: for the SNP and cheaper six percent of the time.
Speaker 1: Then I can go back and look at what's happened
Speaker 1: more expensive sixteen percent at the time. It's more expensive
Speaker 1: sixteen percent at the time, cheaper four percent at the time.
Speaker 1: My apologies, So it's expensive, and we can go back
Speaker 1: in time and look at what's happened to the market
Speaker 1: over the next few years from this valuation level in
Speaker 1: the past. It's not a prediction, it's just saying what's
Speaker 1: happened from this valuation level in the past. And the
Speaker 1: answer to that is year forward returns of average three
Speaker 1: to five two year forward's eight to ten not negative
Speaker 1: because the market average nine to ten percent returns during
Speaker 1: those twenty eight years, and that's something we've come to
Speaker 1: get used to. It not necessarily will continue in the future,
Speaker 1: but that's what we've come to get used to. And
Speaker 1: we're more expensive than that. So from the sixteenth percent
Speaker 1: to I'll expected returns about three to five percent eight
Speaker 1: to ten over the next two years. So if we
Speaker 1: get closer to what we're thinking over the next year
Speaker 1: three to five. And when we tested this over the
Speaker 1: seventeen years before we went live, we were able to
Speaker 1: add about seven points to that. So if we can
Speaker 1: add anywhere close to that and the market is only
Speaker 1: earning three to five, people really going to enjoy those
Speaker 1: extra turns at that time. Our best returns are actually
Speaker 1: in not up three to five pc, which is very
Speaker 1: good returns above average returns, but negative returns. We had
Speaker 1: double digit spreads in all the four years that we
Speaker 1: looked at that the market in our tests that the
Speaker 1: market was down, uh, and that will be very precious
Speaker 1: to have not lose money. So you on the index
Speaker 1: plus protection. It's a more painless way to UH be
Speaker 1: long long the market, and we think people will stick
Speaker 1: with us because it's UH. The underperformance periods we'll be
Speaker 1: way mitigated based on the way we're doing it. And
Speaker 1: we're already long a dollar in the market and you're
Speaker 1: only owning companies that are within the SMB five hundreds.
Speaker 1: So my assumption is you can scale this pretty easily right. Well,
Speaker 1: not only that, but we also don't buy big positions
Speaker 1: and small pieces of the SMP five hundreds. So we're
Speaker 1: not worried about capacity here. We're just worried about getting
Speaker 1: high returns for investors. That that is quite fascinating. I
Speaker 1: very vividly remember this book coming out in something like
Speaker 1: that and and exploding like it came out of left field.
Speaker 1: I don't think a lot of the investing public, um
Speaker 1: necessarily knew who you were, and suddenly this book was everywhere. Um,
Speaker 1: what motivated you to write this twenty years ago, twenty
Speaker 1: plus years ago? I can't really explain why, But I
Speaker 1: love investing and I always wanted to write and teach,
Speaker 1: and investing is what I know about. So I teach investing.
Speaker 1: I've been doing that at Columbia for twenty two years
Speaker 1: and always wanted to write about it. And so you
Speaker 1: can be a stock market genius. See. I can't even
Speaker 1: think of the name because it was such a bad name,
Speaker 1: but uh, it was a great marketing name. You may
Speaker 1: not love the name because it doesn't really describe the
Speaker 1: contents of the book that well, but it's certainly caught
Speaker 1: people's attention. Well, it was really supposed to be any
Speaker 1: fool can be a stock market Genius, but only fools
Speaker 1: came out with a book. Uh, and so I had
Speaker 1: about twenty four hours to change the name, and I
Speaker 1: was canvassing my family and my father said something like,
Speaker 1: how about you can be a stock market genius? And
Speaker 1: then in parentheses, even if You're not too smart? And
Speaker 1: I kind of giggled about it, and uh, and we
Speaker 1: put that in it. It turned out to be one
Speaker 1: of the worst titles ever on the that the parentheses
Speaker 1: even if You're not too smart is part of that. Yeah.
Speaker 1: So but I just really it was really a collection
Speaker 1: of war stories from you know, we had talked about
Speaker 1: we had run outside money for ten years or in
Speaker 1: fifty before fees for that period, and uh, how do
Speaker 1: we do that? And you know, how can you do that?
Speaker 1: And what what what are the what's the way you
Speaker 1: go about attacking that? And I just had a fun
Speaker 1: time writing about the war stories and having a good
Speaker 1: time with it. So let's talk a little bit about
Speaker 1: some of those war stories. First, how old does the
Speaker 1: book hold up twenty years later? Well, I have five
Speaker 1: kids and made all my kids read it number one
Speaker 1: and uh, so I still think it's uh, everything in
Speaker 1: there is very valid, you know, any hedge fund managers.
Speaker 1: I did not write it for hedge fund managers. That's
Speaker 1: really who took two with the most, which is had
Speaker 1: to be an interesting surprise. Yeah. I really wrote it
Speaker 1: to be friendly and funny and and you know, just
Speaker 1: have a good time doing it. And I thought I
Speaker 1: was writing to an audience of average people. But you know,
Speaker 1: I hadn't started teaching Columbia yet, and I realized as
Speaker 1: soon as I taught my first class back in that
Speaker 1: I think I really wrote this uh at an NBA level,
Speaker 1: because it was about at their level, and that wasn't
Speaker 1: my uh my goal. But you know, now lots of
Speaker 1: these big catch funds handed out first day when someone
Speaker 1: walks in and says, go read this. So let's talk
Speaker 1: a little bit about spinoffs, which was such an important
Speaker 1: part in the first Let's call a third of the
Speaker 1: book ninety. The twenty years or more that preceded this
Speaker 1: a lot of them and a lot of conglomerates being formed.
Speaker 1: Would make sense that the next year that follows it
Speaker 1: sees a lot of spin offs. Um. But since since
Speaker 1: the book came out, we've seen certainly in the past
Speaker 1: decade or so, less and less spinoffs. Do you think
Speaker 1: that part of the analysis still holds true or is
Speaker 1: this just like everything else? No, No, there are there
Speaker 1: are plenty of spinoffs and it's in here uh now,
Speaker 1: And people have done studies up through last year that
Speaker 1: showed that they did much better than the market as
Speaker 1: a whole, But that wasn't really my point. My point
Speaker 1: is is that the nature of spinoffs is, uh, they're
Speaker 1: not underwritten written securities. They're usually given to people who
Speaker 1: don't want them, right, and uh, there's an interesting behavioral
Speaker 1: element that you describe, and nine is long before behavioral
Speaker 1: finance was everywhere, which is I expect people to get
Speaker 1: this and say, this is not why I bought X
Speaker 1: y Z. I certainly didn't buy it for the ABC spinoff.
Speaker 1: So there's a tendency for a lot of people to
Speaker 1: not even analyze it, sell it. And suddenly there's a
Speaker 1: good cheap property there, right, So it may be cheap,
Speaker 1: it may not be cheap. They're not usually well followed,
Speaker 1: so there I would call it miss price. It's ripe
Speaker 1: for miss pricing. It doesn't really all the studies that
Speaker 1: show the average spinoff does this or outperforms or doesn't outperform,
Speaker 1: doesn't matter. What I was really trying to show people
Speaker 1: is places to look where things may be miss priced.
Speaker 1: And here where people have never followed this company before.
Speaker 1: It's not being sold by an investment firm, given to
Speaker 1: people who don't really want it. It's ripe for miss pricing.
Speaker 1: It could be under priced, could be overpriced, doesn't matter
Speaker 1: which one it's. Uh. You know I I described in
Speaker 1: the book that it's you know, no fun to take
Speaker 1: a shovel and dig holes, but if you're digging, digging
Speaker 1: for buried treasure gets more interesting. And so this is
Speaker 1: an area where has a big red X on it
Speaker 1: where there could be a nice treasure underneath if you
Speaker 1: dig here. So it's worth doing the work uh in
Speaker 1: these areas, so right for miss pricing is what I'd say.
Speaker 1: It doesn't really matter how the average spinoff does. However,
Speaker 1: they have done very well. There are some things, as
Speaker 1: you mentioned, uh, built into the system that make people
Speaker 1: uh get rid of them uh, and and there are
Speaker 1: a lot of other areas in the market that does that.
Speaker 1: But the idea beyond the whole book was sort of
Speaker 1: look where you know, I started off with my in laws.
Speaker 1: The first chapter was about my in laws who uh
Speaker 1: used to shop in Connecticut for antiques and yard sales
Speaker 1: and and and country auctions and and things like that.
Speaker 1: Artwork you mentioned artwork and sculptures and all these things.
Speaker 1: And they're looking off the beaten path. They're not looking
Speaker 1: in Manhattan on Madison Avenue or you know, Fifth Avenue.
Speaker 1: They're they're really looking off the beaten path, trying to
Speaker 1: find things that are undiscovered. But I made the point
Speaker 1: of saying, they're not looking for the next Picasso. They're
Speaker 1: not finding a painting in some yard sales saying, hey,
Speaker 1: this guy is gonna be the next Picasso. Uh, that's
Speaker 1: really hard to do. What they're really looking for is
Speaker 1: a painting that they found the same artist had had
Speaker 1: on a painting that's of the similar idea that just
Speaker 1: went up for auction for three times the price it's
Speaker 1: being offered for over at South BEA's. So they they
Speaker 1: recognize that, uh, right now, a similar painting just went
Speaker 1: for three times as much. That's a lot easier to
Speaker 1: do than to project or predict the next Picasso. And
Speaker 1: so that's what they were doing. That's what you're doing
Speaker 1: the spinoff area. You're looking and plate your your bargain
Speaker 1: comes because you're looking a little harder than other people.
Speaker 1: You're looking at things that are a little harder to do,
Speaker 1: a little harder to find, probably smaller than most people
Speaker 1: are willing to look at. Not the main idea. Usually
Speaker 1: these are discarded things, and these are all things that
Speaker 1: are right for miss pricing makes a lot of sense
Speaker 1: in the book there there's something that correct me up.
Speaker 1: You right, never trust anyone over thirty and never trust
Speaker 1: anyone thirty and under. Essentially, never trust anyone. Tell us
Speaker 1: a little bit about your thought process with that. Well,
Speaker 1: when both of us were growing up, that was a saying,
Speaker 1: never trust anyone over thirty. I think anyone who's younger
Speaker 1: than we are probably doesn't even know that expression. So
Speaker 1: from them, Yeah, back in the sixties when we were
Speaker 1: growing up, that's what you were. You know, don't trust
Speaker 1: the man, you know, anyone over thirty and and Uh,
Speaker 1: that was just my way of saying that you have
Speaker 1: to be your own boss. You have to look out
Speaker 1: for your caveat emp to war. In the investment world,
Speaker 1: like everywhere else, Uh, most people are trying to sell
Speaker 1: you things, they have an angle. It's very hard for
Speaker 1: you to discern who is or who isn't on your
Speaker 1: side unless you do the work yourself and know what
Speaker 1: you're doing. And so it's very important to know that.
Speaker 1: And that's uh. You know. I gave a talk at
Speaker 1: Google number of months back, and I started it this way.
Speaker 1: I said, even Warren Buffett says that most people should
Speaker 1: just index. And I started the talk saying I agree
Speaker 1: with him. Then I left. I didn't actually leave if
Speaker 1: I said, but then again, Warren Buffett doesn't mean index,
Speaker 1: and neither do I. How come? And I explain the
Speaker 1: real opportunity set that's still out there. You know, I
Speaker 1: get um, you know, is this still any good? Does
Speaker 1: this stuff still work? I get a you know, I
Speaker 1: get a hand raised in my classic Columbia every year,
Speaker 1: at least for the last five six years, a student
Speaker 1: will raise their hand and sort of say, hey, Joel,
Speaker 1: congratulations on a nice thirty five or thirty seven year career.
Speaker 1: But isn't the party over for us? There's more computers,
Speaker 1: ability to crunch numbers, hedge fund smart people doing this stuff.
Speaker 1: You know, are we gonna have the same chances that
Speaker 1: that you had and so my students are second year
Speaker 1: NBA is roughly twenty seven years old on average. So
Speaker 1: I tell this is why I answer. I say, I'll
Speaker 1: tell you what. Why don't we just go back to
Speaker 1: when you guys learned how to read. Let's take a
Speaker 1: look at the most followed market in the world. That
Speaker 1: would be the United States. Let's look at the most
Speaker 1: followed stocks within the most followed market in the world.
Speaker 1: Those would be the SNP five hundred stocks. And let's
Speaker 1: take a look at what's happened to the SNP five
Speaker 1: hundred since you guys, you know, learned how to read.
Speaker 1: So I take them back twenty years when they were
Speaker 1: seven years old, and I say from to two thousand
Speaker 1: the S and P five hundred doubled from two thousand
Speaker 1: to two thousand two, halved from two thousand two to
Speaker 1: two thousand seven, it doubled from two thousand seven to
Speaker 1: two thousand nine and a half, and from two thousand
Speaker 1: nine to today it's roughly tripled, which is which is
Speaker 1: my way of telling them that people are still crazy.
Speaker 1: And uh, it's way understating the case. Because the SNP
Speaker 1: five hundreds and average of five hundred companies if you
Speaker 1: lift up the covers and look at the dispersion going
Speaker 1: on between those five hundred companies between which are in
Speaker 1: favor at any particular time, in which are out of favor,
Speaker 1: the price movements are uh much wilder than what the
Speaker 1: average of five hundred companies doubling and having doubling and
Speaker 1: having that doesn't even begin to tell the story. So
Speaker 1: if you drew a horizontal line uh and called that
Speaker 1: fair value, like Ben Graham said, and then you draw
Speaker 1: a wavy line around that horizontal line, uh and call
Speaker 1: that stock prices, the market is pitching us opportunities all
Speaker 1: the time between stocks that are way below fair value
Speaker 1: and way above fair value. The reason investors don't beat
Speaker 1: the market has nothing to do with the market is
Speaker 1: not throwing us pitches, and that it's not still emotional.
Speaker 1: Their behavioral problem, there's agency problems, there's a lot of
Speaker 1: other issues going on, But it's not because we're not
Speaker 1: getting really great pictures all the time. People are still emotional.
Speaker 1: If you're cold and calculating, And go back to what
Speaker 1: we talked about in the beginning, where stocks our ownership
Speaker 1: shares of businesses and you're just cold and calculating, about
Speaker 1: what they're worth. You can really take advantage of the market.
Speaker 1: I actually, uh try to explain this concept. A friend
Speaker 1: of mine who's an orthopedic surgeon, asked me to speak
Speaker 1: to a group of his uh buddies, you know, at
Speaker 1: a at a big dinner that he was hosting for
Speaker 1: orthopedic surgeons. He said, talk about the stock market for
Speaker 1: in half an hour, try to explain it, and then
Speaker 1: take Q and A. So I talked for half an hour.
Speaker 1: I started taking Q and A, and when I was done,
Speaker 1: the questions were something like, hey, oil went up two
Speaker 1: dollars yesterday, should I buy some? Or market was down
Speaker 1: one percent yesterday? Should I get out? And my conclusion
Speaker 1: from that talk was that I had just crashed and
Speaker 1: burned and I had not really uh really gotten through
Speaker 1: to these very learned doctors. And then a notoriously difficult
Speaker 1: group to teach anything about because they believed themselves experts
Speaker 1: and everything. Well, I was asked to teach a much
Speaker 1: easier group. This was a group of ninth graders from Harlem. Uh.
Speaker 1: It was a couple of years ago, and it was
Speaker 1: just for one day a week, for an hour a week,
Speaker 1: come in and teach them about the stock market. And
Speaker 1: this was right after I crashed and burned with the
Speaker 1: very learned, educated doctors, and I didn't want to fail
Speaker 1: with the kids. But as you're saying, I had fresh opportunity,
Speaker 1: blue sky with them, you know anything about the stock market.
Speaker 1: So I really thought long and hard about how is
Speaker 1: it gonna explain the stock market to them? And so
Speaker 1: the first day of class, I brought in a big
Speaker 1: one of those old time jars filled with jelly beans,
Speaker 1: you know, big glass jar filled with jelly beans, and
Speaker 1: I passed out three by five cards and I passed
Speaker 1: the jelly bean jar around and I told them to
Speaker 1: count the rows and do whatever they had to do,
Speaker 1: but write down how many jelly beans they thought were
Speaker 1: in the jar. And I went around the classroom and
Speaker 1: collected the three by five cards. Then I said, I'm
Speaker 1: going to go around the room one more time and
Speaker 1: ask you, in front of everybody else, how many jelly
Speaker 1: beans you think are in the jar. And you can
Speaker 1: keep your guests from your three by five cards. You
Speaker 1: can change your guests, that's completely up to you. And
Speaker 1: one by one I went around the room and I
Speaker 1: asked each uh student how many jelly beans they thought
Speaker 1: were in the jar, and I wrote that answer down.
Speaker 1: So let me tell you the results of the experiment.
Speaker 1: The average for the three by five cards. You know,
Speaker 1: the first guests was one jelly beans. That's what at
Speaker 1: average too, And they were actually seventeen hundred seventy six
Speaker 1: jelly beans in the jar, so that that was pretty good.
Speaker 1: And when I went around the room one by one
Speaker 1: asking couple aged person publicly how many jelly beans they thought,
Speaker 1: that average guests was eight fifty jelly beans. And I
Speaker 1: explained to the kids that the second guest was actually
Speaker 1: the stock market. And what I was going to teach
Speaker 1: them to do is be the first guests, be cold
Speaker 1: and calculating, count the roads, be very disciplined and valuing
Speaker 1: the businesses, not influenced by everyone else around them. When
Speaker 1: the second guess what happened, Well, everyone heard what everyone
Speaker 1: else was saying. And in the stock market, everyone read
Speaker 1: the newspapers, they talked to their buddies. They see what
Speaker 1: everyone's saying and doing and reading and seeing the results
Speaker 1: in the news every day, and they're influenced by everything
Speaker 1: around and they're not being cold and calculating and disciplined.
Speaker 1: And so I was going to teach them how to
Speaker 1: be cold and disciplined, and that's what we try to
Speaker 1: do where we have a very discipline process to value businesses.
Speaker 1: And that's what I was teaching them to do, and
Speaker 1: that's what stocks our ownership shares of businesses. And all
Speaker 1: the noise, nine percent of the noise you're reading the
Speaker 1: paper every day, excluding this podcast, is really noise. And
Speaker 1: uh so that's you know, that lesson really resonated, I think,
Speaker 1: and I did much better than the doctors. I would
Speaker 1: have guessed from the beginning you would have done better
Speaker 1: with the kids. I'm a big fan of Sturgeon's law,
Speaker 1: which is everything is junk. And when you talk about
Speaker 1: filtering out the noise and trying to get to the signal, hey,
Speaker 1: the same thing is true across all sorts of different
Speaker 1: um venues. That that noise in the public is just
Speaker 1: it's astonishing and I'm I'm fascinated by that having people
Speaker 1: do it publicly and how that leads to such a
Speaker 1: different result, especially when they came so close on average
Speaker 1: when they were were private. Let's talk a little bit
Speaker 1: about one of your later books, The Magic Formula. How
Speaker 1: did you how did you make this transition from what
Speaker 1: looks like special situations investing to really quantitative investing. Sure, well,
Speaker 1: I'm glad you brought it up that way. So I
Speaker 1: wrote a book called The Little Book that Beats the Market,
Speaker 1: and we don't think of ourselves as quantitative investors, although
Speaker 1: in The Little Book that Beats the Market, we use
Speaker 1: some simple quantitative methods to show people concepts of Ben
Speaker 1: Graham said buy it cheap. His best students a guy
Speaker 1: named Warren Buffett, who said, if I can buy a
Speaker 1: good business cheap, even better, and that made him one
Speaker 1: of the richest people and the people in the world.
Speaker 1: And we have used that philosophy. That's what I teach
Speaker 1: a Columbia. That's what we've used to make money over
Speaker 1: the last thirty seven years, buying good and cheap businesses.
Speaker 1: And wanted to share that with everyone else. And so
Speaker 1: we ran a statistical test just to show that just
Speaker 1: using crude metrics for cheap and crewd crude metrics for
Speaker 1: good and crude metrics for and crude database that we
Speaker 1: could do very well. And so that's what we showed
Speaker 1: in the Magic Formula. And we said the magic formula
Speaker 1: only really has two parts. Cheap. Uh, and for cheap.
Speaker 1: We really rank companies based on a simple metric that
Speaker 1: was earnings before interest in taxes to enterprise value. And
Speaker 1: I usually describe that as rent. So in other words, uh,
Speaker 1: you're buying a house and they're asking a million dollars,
Speaker 1: and your job is to figure out whether that's a
Speaker 1: good deal or not. So there are fairly simple questions
Speaker 1: you'd ask, uh if you're trying to figure that out.
Speaker 1: One would be if I rented out this house, how
Speaker 1: much could I get for it after my expenses on capital? No,
Speaker 1: So return on capital would be how the business invests
Speaker 1: its own money. It's really as the investor, what price
Speaker 1: do I have to pay for the house and how
Speaker 1: much is it gonna earn me? So it's as an investor,
Speaker 1: it's my return on capital. But I don't want to
Speaker 1: confuse that with how the business itself invest its money,
Speaker 1: which is really how I look at return on capital.
Speaker 1: So there's uh so it's really a return on investment. Okay,
Speaker 1: I'm laying out a million dollars getting eighty thousand dollars
Speaker 1: a year in rent. That might be eight percent net
Speaker 1: of my expenses, and interest rates are two or three
Speaker 1: percent That may look pretty attractive. There are other questions
Speaker 1: you'd probably ask, you know, if we were really doing
Speaker 1: this analysis, you'd probably say, hey, what are the other
Speaker 1: houses on the block going for, in the block next door,
Speaker 1: in the town next door? How relatively cheap is this?
Speaker 1: And we do the same thing. We say, how cheap
Speaker 1: is this business relative to similar companies? How cheap is
Speaker 1: it relative to all companies? How cheap is it relative
Speaker 1: to history? That's what we do at Gotham. But for
Speaker 1: the purposes of the little book that beats the market,
Speaker 1: we just did cheap on a free cash flow basis,
Speaker 1: just like how much rent? But and it's a very
Speaker 1: simple metric. And then we said, you know, I described
Speaker 1: this a little bit earlier. We talked about it is
Speaker 1: I was trying to describe I wrote this book for
Speaker 1: my kids, and I said, how do you describe how
Speaker 1: good the business is? And if you read through Buffet's letters,
Speaker 1: it's very clear that he's looking for businesses that are
Speaker 1: in high returns on tangible capital. And I described that
Speaker 1: is every business needs working capital, every business needs fixed assets.
Speaker 1: How well does it convert its working capital fixed assets
Speaker 1: into earnings? So I said, if you're building a store.
Speaker 1: You have to buy the land, you have to build
Speaker 1: the store, you have to set up the displays, you
Speaker 1: have to stock it with inventory. And if all that
Speaker 1: cost your four hundred thousand dollars and the store earns
Speaker 1: you two hundred thousand dollars a year, that's a fifty
Speaker 1: percent return untangible capital. And I compared that to a
Speaker 1: store I called in the book, uh, just broccoli, and
Speaker 1: which is not going to return a lot, and they're
Speaker 1: just broccoli. Is selling just broccoli in your store is
Speaker 1: probably not a good idea. I never tried it, but
Speaker 1: it's probably not a good idea. But you still have
Speaker 1: to buy the land, build the store, set of the display,
Speaker 1: stocked with inventory, still going to cost you roughly the
Speaker 1: same four hundred thousand dollars. But because it's a dumb idea,
Speaker 1: maybe it only earns ten thousand dollars a year. That's
Speaker 1: a two and a half percent return on tangible capital.
Speaker 1: And all I said in the book was, all things
Speaker 1: being equal, if I can get the same price, I'd
Speaker 1: much prefer to own the business that can reinvest its
Speaker 1: money in fifty percent returns, then two and a half
Speaker 1: percent turns, and so What I did for the book's
Speaker 1: purposes is something very crude. I ranked all companies based
Speaker 1: on how cheap they were, and then I took another
Speaker 1: ranking of how good they were, what kind of returns
Speaker 1: on tangible capital they were getting. Then I combined those
Speaker 1: two ranks and bought the best combination of cheap and good.
Speaker 1: And I showed how well that works. It worked so
Speaker 1: well just using these crude metrics that the top ten
Speaker 1: percent combined score for cheap and good did better than
Speaker 1: the second ten percent, better than the third ten percent,
Speaker 1: in order all the way down to the bottom ten percent,
Speaker 1: just showing you the power of how this cheap and
Speaker 1: good work so well. And if I'm getting these numbers right,
Speaker 1: from to two thousand and four, this portfolio would have
Speaker 1: returned about thirty percent a year. Well, at the same time,
Speaker 1: the market would have given you a little over twelve percent.
Speaker 1: Is that about right? Yes, So that was with small
Speaker 1: cap stocks, which unless you're an individual investor, would be
Speaker 1: hard to take advantage of um as a instant sational investor.
Speaker 1: But I also did a similar study for the thousand
Speaker 1: largest companies, you know, the Russell one thousand companies, and
Speaker 1: you know which are very similar to the S and
Speaker 1: P five and that that was versus about twelve still
Speaker 1: also pretty good. Yeah, I'll take it. Uh, possibly a
Speaker 1: little more realistic for UM large investors. We have been
Speaker 1: speaking with Joel Greenblatt. He is the c i O
Speaker 1: of Gotham Asset Management. Be sure and check out the
Speaker 1: podcast extras where we keep the tape rolling and continue
Speaker 1: discussing all things value and index Plus. You can find
Speaker 1: that at iTunes, Overcast, SoundCloud, Bloomberg, wherever your final podcasts
Speaker 1: are sold. We love your comments, feedback and suggestions right
Speaker 1: to us at m IB podcast at Bloomberg dot net.
Speaker 1: You can check out my daily column on Bloomberg View
Speaker 1: dot com. Follow me on Twitter at rid Holts. I'm
Speaker 1: Barry Ridhults. You're listening to Masters in Business on Bloomberg Radio.
Speaker 1: Welcome to the podcast, Joel. Thank you so much for
Speaker 1: doing this. I've been looking forward to this for a
Speaker 1: long time. You and I have never met, never really
Speaker 1: spoken before, but I've been very much aware of who
Speaker 1: you are and what you've done over the years, and UM,
Speaker 1: I have to tell you some of the numbers that
Speaker 1: you have put up, and I know there's only so
Speaker 1: much we can talk about them. Um, are just astonishing.
Speaker 1: We talked about the fifty a year before fees for
Speaker 1: ten years. That's an amazing run. Like Renaissance technology, that
Speaker 1: returned capital to investors. I have to imagine people were
Speaker 1: not especially happy when after ten years of those sort
Speaker 1: of returns you said, here, I have to give you
Speaker 1: this back. What was motivating it was its strictly scale
Speaker 1: or was there were there other factors that said, um,
Speaker 1: I'm done managing other people's money at that At that
Speaker 1: point in time, you know, Uh, that's a great question.
Speaker 1: I thought about that a lot. I love investing. Never
Speaker 1: was going to quit. We had gotten to a size.
Speaker 1: I suppose after ten years of having nice returns that
Speaker 1: we could keep our staff and continue to run our
Speaker 1: internal money. And for me, it's just fun to do. Uh.
Speaker 1: Did you think that at that size you couldn't continue
Speaker 1: generating those sorts of returns? Well? I think, Uh, you
Speaker 1: know I left out You had asked me how we
Speaker 1: did fifty percent a year, and you know one was
Speaker 1: I said we stayed small. Two we were concentrated, and
Speaker 1: three really we got lucky. Okay, that you have to
Speaker 1: have some luck to get those kind of returns during
Speaker 1: uh that period of time, and and so I one
Speaker 1: of the most fortunate people on the planet. I have
Speaker 1: a large family with five kids. I love doing this. Uh,
Speaker 1: I like to do really well. So there's pressure I
Speaker 1: put in myself when I'm running other people's money. Maybe
Speaker 1: I have a little less so and I'm not running it.
Speaker 1: So I don't think it was really a calculated plan
Speaker 1: other than you know, how can I continue to enjoy
Speaker 1: what I'm doing in in the best way and still
Speaker 1: get to do what I like and still work with
Speaker 1: the people I like to do. And so it seemed
Speaker 1: like the right thing to do at the time. I
Speaker 1: guess it's the best way I can. That make sense.
Speaker 1: And it took almost twenty years before you started. It's
Speaker 1: really a fourteen years fourteen years before you said it
Speaker 1: took that long to forget the stress of running other
Speaker 1: people's money. Well, you know, when you own six or
Speaker 1: eight names, one of the issues there is that, uh,
Speaker 1: every two three years, pretty much like clockwork, I'd wake
Speaker 1: up and um, it was of my net worth in
Speaker 1: a couple of days because one or two things weren't
Speaker 1: going our way, either we were wrong or just you know,
Speaker 1: they went the wrong way for a little while we
Speaker 1: knew what we owned we were gonna get paid back,
Speaker 1: and that's a little more stressful. And it had to
Speaker 1: happen when you're that concentrated. That has to happen a
Speaker 1: little more stressful with other people's money. Uh, since I
Speaker 1: know what we owned, and A I'm a big boy,
Speaker 1: so I want to make a mistake, you know, I
Speaker 1: just chalk it up to a learning experience and move on.
Speaker 1: Uh let's just say I think my investors were great,
Speaker 1: but maybe they wouldn't be so kind when that that
Speaker 1: that uh happened and it and it did seem to
Speaker 1: happen every two three years, and I think that's unavoidable.
Speaker 1: So when we developed the strategy to take advantage of
Speaker 1: our principles meaning buying good, cheap businesses and shorting expensive
Speaker 1: ones that uh that we're trading way above what we
Speaker 1: thought they were worth. When we discovered that we can
Speaker 1: actually make more money having diversified portfolios, and that our
Speaker 1: bad days would be twenty or thirty basis points of underperformance,
Speaker 1: not down. Uh, that was a it wouldn't degrade our
Speaker 1: own returns taking other money When we had hundreds of
Speaker 1: stocks on the long and short side, and b it
Speaker 1: wouldn't hurt our own returns because more diversity helped our returns.
Speaker 1: Because when you don't get what you expect, mean, you
Speaker 1: get aberrationally bad returns. Uh. Sometimes that ends up in
Speaker 1: negative compounding. So when you have hundreds of stocks, more
Speaker 1: diversity on each side, you get less aberrationally bad returns.
Speaker 1: It's why insurance companies don't insure five people because even
Speaker 1: if you do great underwriting of those five people, if
Speaker 1: someone steps off a curb, you can tell I don't
Speaker 1: sell insurance. But if some instepts of a curb and
Speaker 1: ruins all your numbers, you know, Uh, it didn't matter
Speaker 1: what kind of underwriting you did, that's a life insurance
Speaker 1: or helping. Yeah. So if you can be right, you know,
Speaker 1: they want to be right on average, so they're gonna
Speaker 1: be right over hundreds or thousands of people. And so
Speaker 1: when we realize that we could make more money being
Speaker 1: more diversified, when you go long short and put on leverage,
Speaker 1: you want that. Uh. It didn't hurt us to take
Speaker 1: outside money because diversity was good for us. Uh. And
Speaker 1: you know, to to cover so many needs, we need
Speaker 1: a big research team so we build up our research
Speaker 1: team and our tech team. They help us trade you know,
Speaker 1: we're uh, we're you know tech team. One guy we
Speaker 1: have you know as m I T chess Champ. Another
Speaker 1: guy was one Google code jam you know at people
Speaker 1: and other guys you know, as smart than as smarter
Speaker 1: than nogat those guys. So I get to work with
Speaker 1: the tech team and they help us trade efficiently. They
Speaker 1: help us, uh, trade tax efficiently, so we're very very
Speaker 1: tax efficient, help us put together the systems where our
Speaker 1: fundamental analysts can cover broad range. So it's been fun
Speaker 1: building a team to do all these different things. So
Speaker 1: I'd say we're fundamentally we we fundamentally value businesses, but
Speaker 1: our tech team helps us put together risk adjusted portfolios
Speaker 1: very well and trade efficiently and be tax efficient all
Speaker 1: those things. And just building this whole thing has, you know,
Speaker 1: doing something with the same principles that we've always used
Speaker 1: has been really just fun. Tell us the most important
Speaker 1: thing people don't know about your background? Oh well, I
Speaker 1: don't know what they don't know. I've written three books,
Speaker 1: and I always tell personal stories within the books, so
Speaker 1: I think I've included lots of embarrassing things I, Uh,
Speaker 1: I don't think I've ever written that I enjoyed playing tennis.
Speaker 1: I did write that I enjoy sailing and that I'm
Speaker 1: not very good at it, and I've been in a
Speaker 1: bunch of close calls with that. But uh, that's probably
Speaker 1: how I spend most of my leisure time as well
Speaker 1: as along with my family. So there's nothing really too fascinating.
Speaker 1: Tell tell us about some of your early mentors. Well,
Speaker 1: you know, one of the reasons I write books is
Speaker 1: because my mentors really came from reading people who were
Speaker 1: kind enough to share with me, uh their wisdom over time.
Speaker 1: And that's you know, people like Andrew Tobias and uh
Speaker 1: and Benjamin Graham and even Buffett in his letters and uh,
Speaker 1: David Dreaming, you know, uh who wrote Contrarian Investment Strategy,
Speaker 1: and John Train who out the Money Masters, and all
Speaker 1: these people really were helpful informing and getting me involved
Speaker 1: in investing. And you know, I wanted to share some
Speaker 1: of the things that I learned too, because that's how
Speaker 1: I learned. Dude, really wasn't so much. Uh, you know,
Speaker 1: some of the people were dead and they were still
Speaker 1: sharing with me, and and some of the people who
Speaker 1: just kind to do so, and I, you know, one
Speaker 1: of my ways, you know, besides the fact that I
Speaker 1: enjoy writing, it was another way that I felt I
Speaker 1: could get back. So let's let's talk about some books.
Speaker 1: What what are some of your favorite books? You've already
Speaker 1: mentioned the two from Graham Intelligent Investor and Security Analysis.
Speaker 1: What other books did you find um influential, be they finance, nonfinance,
Speaker 1: fiction nonfiction? What what really stayed with you? You mentioned
Speaker 1: David Dremmond on Contrarian Strategies. That's a interesting book. Yeah. Well,
Speaker 1: there's a book called The Invisible Heart, which explains basic
Speaker 1: economics to most people, and most people today, you know,
Speaker 1: especially young people are kind of more socialists, isn't that
Speaker 1: isn't the old line, um, socialists uh in your youth
Speaker 1: and capitalists in your older age. I know I'm mangling that. Yes, no,
Speaker 1: I I know the reference, and that's partially true. It's
Speaker 1: just discouraging, uh to me that the the understanding basic
Speaker 1: economics is kind of necessary. And so there's a book
Speaker 1: that's a fiction book, uh um uh. Russ Roberts wrote
Speaker 1: it called The Invisible Heart. Not how many people have
Speaker 1: read it, but it's a very short book that I
Speaker 1: think most people should read. So I would read that.
Speaker 1: I've had my kids read that. Um Russ Roberts also
Speaker 1: maintains a blog. Is it's the same one? Yes? And
Speaker 1: did he does he do? Um? Actually Econ Talker or
Speaker 1: something like that. He probably does. Haven't followed that. It
Speaker 1: is a book about economics. It's a fictionalized book about
Speaker 1: a high school economics teacher. But it's just a pleasant,
Speaker 1: short book way to to learn basic principles. Uh. So
Speaker 1: I'd highly recommend that even if you don't want to
Speaker 1: be in a you know, no formulas, just you want
Speaker 1: to be an econ, you want to understand basic economic principles.
Speaker 1: I think that's one of the best that people haven't seen.
Speaker 1: I think for investing, Moneyball was one of the great
Speaker 1: if you live, if you're a sports fan at all,
Speaker 1: just understanding how to buy undervalued players is is very
Speaker 1: similar to buying undervalued stocks. Uh And so that's a
Speaker 1: really helpful book for most people. I just read a
Speaker 1: book called The Power of Moments, which I really enjoyed,
Speaker 1: which says that most of your uh seminal moments in
Speaker 1: your life really come between the ages of fifteen and
Speaker 1: thirty because you have a lot of first uh. You know,
Speaker 1: it's the first time you graduate and leave home. Might
Speaker 1: be your first girlfriend. Uh, you're graduating college, You're getting
Speaker 1: your first job, you might be getting married, you might
Speaker 1: have kids. All happens in that kind of compact period
Speaker 1: for most people, and people think back for the rest
Speaker 1: of their life about those seminal moments. And it's really
Speaker 1: about a book about creating your own moments. In other words,
Speaker 1: those happen because those are natural. First, those those happen
Speaker 1: naturally because of evolution. But can't you create those kind
Speaker 1: of important moments in your life? And that really comes
Speaker 1: down to creating, doing new things, always creating. You have
Speaker 1: to be a little more creative when you get older
Speaker 1: to create those new things. But those are the things
Speaker 1: you think about, uh, which I think are quite important.
Speaker 1: I'm also reading another book now which I think I'm
Speaker 1: having a lot of fun with which uh is uh.
Speaker 1: I think it's called Never Split the Difference, and it's
Speaker 1: by uh the ex chief hostage negotiator for the FBI,
Speaker 1: you know, just about negotiating and also thinking of uh,
Speaker 1: you know, how you can apply some of these concepts
Speaker 1: to business, you know, to be be effective. So enjoyed that. Uh,
Speaker 1: you know, everyone has to read news interested in investing,
Speaker 1: intelligent investor. You know, I think it's chapters eight and
Speaker 1: twe Buffett always points out, and I agree with that.
Speaker 1: I think Buffett wrote a bunch of letters that were
Speaker 1: compiled by Lawrence Cunningham. Uh, that into topics and that
Speaker 1: was laid out, and I always assigned that in my class,
Speaker 1: which I just think is a great, great book. And
Speaker 1: you've mentioned my three books three times, and so you
Speaker 1: have to read those two tell us about a time
Speaker 1: you failed and what you learned from the experience. I'll
Speaker 1: talk about my worst investment, not specifically what it was,
Speaker 1: but but it was an investment in a trade show
Speaker 1: company that I bought through It was really I created
Speaker 1: through a spinoff, and I was shorted one thing and
Speaker 1: bought another. And I actually paid three dollars for something
Speaker 1: that I was immediately going to get six dollars for.
Speaker 1: But I fell in love with the business and it
Speaker 1: actually ended up did I paid three dollars for to
Speaker 1: eventually in short order went past way past the six
Speaker 1: dollars because I loved the business. It went to twelve
Speaker 1: dollars a share, which was pretty good. But I had
Speaker 1: a very large position in it at that time. And
Speaker 1: what I loved about the busines this was they ran
Speaker 1: a computer trade show called Comdex in UH in Las Vegas.
Speaker 1: And I love the business because plenty of space in
Speaker 1: Las Vegas. If they got more clients to display at
Speaker 1: their trade show, UH, they could just rent more space
Speaker 1: for two dollars and resell it for sixty two dollars.
Speaker 1: They didn't have to commit it, so that it was
Speaker 1: like a sixty dollar contribution for every uh incremental sale
Speaker 1: they could make. And that's generally called operating leverage. And
Speaker 1: that's what I loved about the business. And I think
Speaker 1: people are very familiar with financial leverage. Right if you
Speaker 1: put up a dollar and buy borrow nine dollars and
Speaker 1: buy something worth ten dollars, you realize that if that
Speaker 1: ten dollar thing you bought falls a dollar or two,
Speaker 1: you're gonna go broke. And everyone understands that that's very straightforward. UH.
Speaker 1: So this was my lesson in operating leverage. You know. Unfortunately,
Speaker 1: after nine eleven, right before nine eleven, the trade show
Speaker 1: bought another trade show. They brought a lot of money
Speaker 1: to buy it, and then nine eleven happened and people
Speaker 1: didn't want to travel. And so I learned a lesson
Speaker 1: in operating leverage, where when you don't get that sixty
Speaker 1: two dollars in it and it only cost you two dollars, Uh,
Speaker 1: sixty dollars of less earnings dropped straight to the bottom
Speaker 1: line as well. Uh. And that's called operating leverage. And
Speaker 1: I just thought i'd described that to you so that
Speaker 1: people would realize that on the way up, just like
Speaker 1: financial leverage, it's a lot of fun, and on the
Speaker 1: way down, operating leverage on the way down is not
Speaker 1: very much fun. So I got out of most of
Speaker 1: my stock at about a dollar, So I'll just leave
Speaker 1: it at that and say that's a less of my investment.
Speaker 1: Lesson in operating leverage at least be aware um our
Speaker 1: last two questions, Uh, what sort of advice would you
Speaker 1: give a millennial or recent college graduate who told you, Hey,
Speaker 1: I'm interested in going into financials as a career. Well,
Speaker 1: you know, I I've taught Columbia, as I mentioned, for
Speaker 1: the last twenty two years, and so I tell my
Speaker 1: students that first had class. Actually I tell them that,
Speaker 1: you know, I don't think there's a lot of social
Speaker 1: value in being a investment manager. Uh it's not that
Speaker 1: I don't think, Uh, investors who do work help set
Speaker 1: prices and allocate capital and all those things. But I
Speaker 1: just think, ay, they're not very good at it, and
Speaker 1: be it would all get done without you and smart
Speaker 1: people doing this too much horsepowered rather than them go
Speaker 1: into other fields. I have loved being in this field.
Speaker 1: I enjoy it and there's nothing wrong with it. But
Speaker 1: what I tell my students is I'm even one step
Speaker 1: removed from doing something I don't think is that socially
Speaker 1: valuable because I'm teaching you how to do something this,
Speaker 1: you know, So what am I doing here? And so
Speaker 1: what I make my students promise, and I think they
Speaker 1: take to it well, is that if I do teach
Speaker 1: them and I am helpful in in in learning how
Speaker 1: to do this, and they enjoy it, there's nothing wrong
Speaker 1: with it. It's a great thing. But they should think
Speaker 1: of a way to give back they you know, we
Speaker 1: get way overpaid in this businesses we're successful, and if
Speaker 1: they're successful with what I teach them, and I would
Speaker 1: say that any young person, if they're successful in this field,
Speaker 1: I think they should really think of different ways that
Speaker 1: they're clearly smart people, they're clearly uh driven people, they're
Speaker 1: they're thoughtful, and so they should be able to think
Speaker 1: of a way to give back and use those skills
Speaker 1: for that. And so that that's what I tell young
Speaker 1: people who want to go into the investment business. And
Speaker 1: our final question, what is it that you know about
Speaker 1: investing today that you wish you knew thirty seven years
Speaker 1: ago when you were first started. I would say probably
Speaker 1: the secret to being successful is patients. The big secret
Speaker 1: that no one bought him and as well tell everyone
Speaker 1: is really just having a longer time horizon than most
Speaker 1: people and understanding what you're doing, meaning you're buying businesses
Speaker 1: and if you're good at valuing them. I actually make
Speaker 1: a promise to my students first day of class every year.
Speaker 1: I promised them, if they do good valuation work, the
Speaker 1: market will agree with them. I just never tell them when.
Speaker 1: It could be a couple of weeks, could be two
Speaker 1: or three years. But if they do good work, the
Speaker 1: market will agree with them. And to keep that in
Speaker 1: mind to continue to do good work and have patience.
Speaker 1: And you know, since you can check your stock price
Speaker 1: thirty times a minute, now, I think you know we
Speaker 1: used to get when I was, you know, coming into
Speaker 1: the business, used to get a quarterly statement and throw
Speaker 1: it right in the garbage. You know, you didn't really
Speaker 1: care that much. Now your minute a minute. You know,
Speaker 1: even our best investors, you know, billion dollar UH endowments,
Speaker 1: expect weekly returns from us in our private funds. I
Speaker 1: have no idea what they do with that information, but
Speaker 1: that's what they're asking for. And everyone's judged on very
Speaker 1: short time horizons. So if you can step back and
Speaker 1: take a longer time horizon, that is the big secret
Speaker 1: that I could share. And the sooner you learned that,
Speaker 1: and the sooner I learned that, the better off that
Speaker 1: they and and I will will be. We have been
Speaker 1: speaking with Joel Greenblatt, CO c i O of Gotham
Speaker 1: Asset Management. If you enjoy this conversation, be sure and
Speaker 1: look up an Inch or down an Inch on Apple iTunes,
Speaker 1: Bloomberg Overcast, and you could see any of the other
Speaker 1: two hundred such podcasts we've done previously. We love your comments,
Speaker 1: feedback and suggestions right to us at m IB podcast
Speaker 1: at Bloomberg dot net. I would be remiss if I
Speaker 1: did not thank the Crack staff that helps us put
Speaker 1: this podcast together each week. Caroline is my engineer today,
Speaker 1: Medina Parwana is our producer. Taylor Riggs is our booker.
Speaker 1: Mike Batnick is our head of research. I'm Barry Retolts.
Speaker 1: You've been listening to Masters in Business on Bloomberg Radio.