Joel GreenblattSuperinvestors

Joel Greenblatt Special Situation Investing Notes Part 1

One of the blogs I read often ( recently did a blog post that contained links to some of his notes from a value investing class audited at Columbia. He doesn’t list who the investor is in his notes, as he says he wants his readers to be unbiased as they read through the notes. As I read through the first link that he calls Class Notes-Introduction to Value Investing for Special Situations, it’s clear that the class is being taught by Joel Greenblatt.

I’ve studied Greenblatt in detail and have come across similar notes and even some videos on the classes he teaches at Columbia, where he is an adjunct professor. You can read my resource page on Greenblatt for more info/links/videos. He is famous for making 40% returns from 1985-2005, and 50.0% gross returns (from 1985-1994) while managing outside funds at his hedge fund Gotham Capital. Those are annual returns… over 20 years I don’t know any other investor that has done better. $10,000 invested in 1985 became $8.3 Million in 2005. Not bad…

Anyhow, I thought I’d post a few notes from John’s notes at CSInvesting. So these are notes from notes… just a few highlights. I strongly recommend you read the whole document, as well as bookmark John’s site. There is a lot to learn there.

Here are some quick thoughts from the first part of the compilation of notes from Greenblatt’s class:

Prices move in much wider yearly ranges than values do. 

In other words, prices are much more volatile than values. This creates opportunity for investors. (He says to look up the 52 week ranges for any big-cap stock like WMT, GOOG, CSCO, AAPL, etc… you’ll see yearly stock price ranges of 50-100% consistently. There is no way the actual values of those companies move around that much during the course of each year. He said he doesn’t really know for sure why this occurs over and over, but he doesn’t care. He only wants to take advantage of it by buying what’s undervalued when the market offers it.

Beating the market is very achievable, but not easy. You have to know how to

  1. Value companies and
  2. Wait for the right price

So why don’t people beat the markets? He says most people are smart enough, especially on Wall Street, but they are too short term oriented and they don’t put their valuation work in the proper context. He said markets are most inefficient on a 3-5 year time horizon (this is a very important part of where my own edge comes from). The ability to look past where most people look (next quarter or next year) is absolutely crucial. Patience is a big edge.

How has he been able to compound money at 40% per year for 20 years? By simplifying his thinking… like Jim Rogers, he sits around and does nothing until there “is money lying on the floor and all he has to do is walk over and pick it up”. He is content to do nothing until he finds the right opportunity.

I love Greenblatt’s humble attitude and outlook. He has previously stated that he’s no smarter than the average money manager and he doesn’t do better analysis. So how can he outperform so dramatically? The answer is patience and the method he uses to implement his investment philosophy. He swings at fat pitches and passes on anything he doesn’t understand. He thinks differently than the crowd. Like Templeton said:

It is impossible to produce a superior performance unless you are doing something different from the majority.

These notes represent more of the conceptual side of Greenblatt’s ideas. They are very simple, basic investment principles:

  • Value investing works (low P/E, P/B, P/FCF, etc…) 
  • Prices move around much more than value does, consistently creating opportunities for profit. 
  • Think of stocks as part ownership of real businesses
  • Invest using a margin of safety
  • Know your circle of competence
  • Take advantage of Mr. Market’s irrationality (As Buffett said “Profit from the folly rather than participate in it”)
  • Do simple things. Investing is not hard. Do things you understand. 
  • Invest with 3-5 year time frame (perhaps the biggest edge and most inefficient part of the market because it’s the part where most investors don’t/can’t/won’t participate in because of emotions and lack of patience). 
In my next summary of John’s notes from the class, Greenblatt gets more into “How to Beat the Market”…

12 thoughts on “Joel Greenblatt Special Situation Investing Notes Part 1

  1. John,

    I have been slowly reading many articles through your website. I would like to say, you have insightful thoughts and can articulate them well!

    I am curious on how you bucket your portfolio. I agree with price moves more than value and I agree one should invest in things that are undervalued as time can play on side. I am curious on how you categorize your undervalued investments. Through my lens, there are special situations (spinoffs, m&a, recap, restructuring, etc), there are enterprises/franchises that are undervalued to its sustainable earnings/normalized earnings power, and then there are balance sheet bargains. Do you agree with this model?

    Then, how do you allocate your portfolio between the different types of investments? Or is it just based on your conviction on an idea? (i.e. how do you look at portfolio allocation? what is your approach?)

    Thank you!

    1. Thanks for the comment. And good questions. I should probably write another post with some thoughts on portfolio management. But the short answer is yes, I think of investments in two broad categories. My ideal stock is a great operating business with predictable cash flows and high ROIC’s that can be bought at cheap prices (10x or so). Those are the businesses that will grow intrinsic value over time, and are what I call Compounders. Those are hard to come by at cheap prices, but occasionally you can find one to buy and own for a long time as it compounds value for you.

      In the meantime, I keep watch for situations such as asset sales, spinoffs, cheap sum of parts, restructurings, etc…

      So basically, you described pretty accurately my two main investment situations… but I don’t necessarily go out and say “Okay I have enough Compounders, let’s look for some special situations”, or anything like that. I simply go into the office everyday and look for ideas. Any ideas that I can understand and can reasonably determine value.

      So I simply “take what the defense gives me”. That–very simply–is my approach to portfolio management. Allocate cash to ideas that I can identify large gaps between price and value.

  2. What do you think of extremely discounted companies (say, P/E under 3) that have significant uncertainty? For example, many Chinese companies and their corporate structure (without mentioning the fraud stigma), or miners operating in unstable regions.

    1. Hi Pat, I love extreme discounts. P/E’s under 3 are great, but as you know often times they come with undue risk. So it’s not the P/E that bothers me, it’s the risk. I’m extremely risk averse with my investment decisions, and I pass on many opportunities that seem to have a possibility of huge returns if the downside is not protected. I’m very leary of situations such as the ones you mentioned… I don’t invest in things that I don’t understand or can’t handicap the risk with any degree of certainty. I don’t like the small Chinese companies simply because it’s too difficult for me to figure out what’s going on there. Same goes for miners in unstable jurisdictions. That’s not to say you can’t find bargains there, because many people like me reject those areas as “too risky”. So if you have some sort of edge (maybe you live in or near that region or have a way of confirming which companies are legitimate). If you have a way to filter through those ideas, then you very well might find value there.

      For me, I look at things I can understand, and then I look for low risk obvious value. And the low P/E is ideal, but you mentioned uncertainty. I like predictability over the long term. I don’t mind uncertainty in the short term, as that often provides us with opportunities, but I want long term stability and predictability.

      It takes a lot of pitches to find the fat one sometimes…

  3. Hi,

    Great site with so much useful information. One general question I have when I see the performance numbers of Walter Schloss, Joel greenblatt etc.., are the yearly performance percentages quoted after tax or before tax? Because if you buy a index fund and hold it, there is no yearly tax to pay. Whereas if you are buying and selling stocks, your gains have to be subtracted by the tax you are going to pay for it.

    1. Hi Vani, yes, typically both the index and the performance numbers are both reported pretax. And you’re right, there are some tax advantages to holding something over the long term as opposed to paying capital gains yearly. But the results from the superinvestors above still trounce the S&P even factoring in tax. And for apples to apples comparison, if you’re going to discount the investors who pay tax more regularly, you’d have to set up a quasi tax deferred liability for the S&P index fund.

  4. Dear John,

    Thanks for sharing your thoughts with us!

    Quick question, are there any new (more recent) notes (say: 2012-13-14-15)?
    I ve found the notes very useful to me but just wonder if there is an “update” out there.

    Thanks in advance!

    Best regards,

    1. Hi Jan,
      I don’t know of any updates, but they could be out there. I’ll link to them here if I come across some of them.

      1. Many thanks!

        Maybe a small follow up question: are there any other good study resources you would recommend for special situation investing? Seems the notes and his famous book are the only quality stuff available on special situations. I would definitly love to study some more technical material (rather than concepts only).


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