I will summarize the notes of Joel Greenblatt’s lectures in Columbia Business School back in ’05. His books are great material for any investor starter or otherwise. These quick reads excel in both great examples and clarity of teaching. I recommend both You can be a stock market genius and The Little book that still beats the market.
Some great lessons from his lectures:
Singular focus on normalized EV / EBIT and ROIC
We (Gotham Partners) know a little bit more than what I wrote in the book (The Magic Formula). But I figured if you could double people’s returns in stocks or close to triple the return in small stocks that was worthwile. We do look for these two things (high ROIC and high earnings yield), but instead of looking at last year’s earnings we use normalized earnings. Most people can’t figure that out. We can’t figure it out for most stocks, but for those stocks where we can figure it out, we are looking for companies with high returns on tangible capital on a normalized basis and high earnings yield based on normalized earnings. That is just very logical.
Problems with valuation shorting
My quibble with long/shorts – the guys who do special situations in shorts where it is a scam or the company will run out of money. I like those type of shorts though I am not particularly good at them. If you are doing valuation shorts then I don’t like that. That strategy blows up every seven or eight years – the shorts go up and the longs go down and that happens to every quant guy. I am not saying a long/short hedge fund doesn’t make sense. But I don’t value short term volatility because I take a three or four year view. Then why give up 2.5% a year in returns by shorting. I am not adding value. It doesn’t add value because I am losing 2.5% a year and I don’t care about volatility.
Break out no-growth value & value from growth
Simplify everything – what is it worth now if they just stopped growing? Then if they take some of their incremental dollars capital and buy stuff what kinds of incremental returns do I think they are going to get on that? So I break things into two pieces generally. [..] I have to make an assumption of what will they do with that cash (on no-growth value).
Go check out the lecture notes here.