JOHN WILEY AND SONS INC
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The Little Book That Beats the Market (Little Books. Big Profits 8) Kindle Edition
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An Exclusive Q&A with Author Joel Greenblatt
In my mind, the principles of value investing have not changed. As we've learned yet again, markets can be volatile and emotional. They often go to extremes of pessimism and optimism, and prices can and often do fluctuate wildly and significantly over short periods of time. As a result, Mr. Market can provide some excellent opportunities to purchase bargain priced stocks when people are unduly pessimistic. This is where value investing comes in. Buying companies below their true value is the road to being a successful investor. The magic formula found in the Little Book seeks to buy a group of above average companies but only when they are available at below average prices. Because it is a formula, it seeks to do this in an unemotional way that can take advantage of the market's mood swings. Ben Graham taught us these lessons in the 1930s and the principles still hold as well today as when he first wrote them down more than 70 years ago.
Do you think individual investors should re-think their investment strategy as a result of the recent market crash and recession?
I think the best lesson that can be learned from the recent price drop and partial recovery is that stocks are volatile. For most people, stocks should represent a portion of their investment portfolio because I still believe that over the long term they will provide superior returns relative to most alternative investments. However, whether that portion of an investment portfolio devoted to stock investments should be 40% of an investor's portfolio or 80% is a very individual decision. How much are you willing (or able) to lose before you panic out? There's no sense investing such a large portion of your assets in a long-term strategy if you can't take the pain when your chosen strategy doesn't work out for a period of years. The "magic formula" found in the book can underperform the market for years. It can also lose money if the market goes down. But it is also a strategy that makes a lot of sense and that should work well for investors over the long term.
Can you explain the Magic Formula's basic strategy in one sentence?
The Magic Formula strategy is a long-term investment strategy designed to help investors buy a group of above-average companies but only when they are available at below-average prices.
You make reference in the new afterword to receiving a number of emails from readers after the The Little Book That Beats the Market was published. Could you share with us some of the comments you received?
I received many emails after the first edition of the book was published. Some suggested that the strategy was working great for them while others reported that they had waited over a year and the strategy was underperforming. These results and emails are consistent with the message of the book. Over the five years since the book was published, the strategy earned very nice returns for investors, but the ride was bumpy. Not only did the formula underperform for a period of time, in 2008 it lost money along with the market. Overall, the formula performed quite well but only for those who maintained a true long-term perspective. This is easier said than done. In the new afterword, I try to give more facts, color and information about the strategy that I hope will help investors be successful in taking full advantage of the magic formula over the long term. Of course, I also got plenty of emails where investors just asked us to do it all for them. Other emails asked us to apply the formula internationally. As a result, we have worked on both of these projects over the last several years.
In the new afterword, you write "Beating the market isn't the same thing as making money." Can you elaborate on this and why it's a difficult concept to swallow at times?
Since the strategy involves buying a portfolio that is 100% long the stock market, if the stock market goes down, our portfolio may well go down, too. If the market drops 40% and we beat the market by losing only 38%, this is small consolation. As I say in the afterword, while I firmly believe that for most people an investment in the stock market should represent a substantial portion of your investment portfolio, how big that portion should be can vary widely. For some it can be well over half of assets, for others well less than half might be appropriate. The magic formula strategy is a wonderful strategy for that portion of your portfolio that you choose to invest in the stock market. In fact, I truly believe that the magic formula remains one of your best options. How much to invest in the stock market, however, is a very personal decision that should be partially based on your ability to withstand short-term negative price movements. One encouraging fact, though, discussed in the afterword is the performance of our large cap portfolio over the last decade. Over that period, the market as measured by the S&P 500 was actually down, yet our backtests showed that following the formula over those same ten years would have resulted in a more than tripling of your money. Unfortunately, those great long-term returns came with plenty of bumps, including some not so short periods of losses and underperformance. But once again, if the formula worked every day, every month and every year, everyone would follow it and it would be ruined. Fortunately, it's not so great, and as a result I strongly believe that long-term investors should continue to benefit from the magic formula for many years to come.
From Publishers Weekly
Copyright © Reed Business Information, a division of Reed Elsevier Inc. All rights reserved. --This text refers to an out of print or unavailable edition of this title.
- ASIN : B000YIUWFQ
- Publisher : Wiley; 1st edition (April 21, 2008)
- Publication date : April 21, 2008
- Language : English
- File size : 331 KB
- Text-to-Speech : Enabled
- Screen Reader : Supported
- Enhanced typesetting : Enabled
- X-Ray : Enabled
- Word Wise : Enabled
- Print length : 106 pages
- Lending : Enabled
- Best Sellers Rank: #94,511 in Kindle Store (See Top 100 in Kindle Store)
- Customer Reviews:
Top reviews from the United States
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My brother is a financial analyst for a fortune 500 company and could not get me to understand the stock market and mutual funds etc- for the life of him! He read this book and then forced me to read it as well. I am glad I did because it was easy to follow and made me excited about investing my money into avenues that will provide much higher yields that 5 to 8% a year.
The author wrote this book for his middle school children to help them understand investing in the adult world so to speak- Well he did a phenomenal job and published it for the rest of us-
A good pick for beginner investors or people who would like to invest their money in stocks and funds with little background in the field. This would also be a good "starter" book for someone who wants to get into the stock market.
It was extremely simplistic and devoid of material information. If you know absolutely nothing about investing, and you are a teenager, it might be a useful story to listen to. But for anyone else I recommend you don't waste your time.
The audio CD makes really big claims (about unhelpful other sources of information are, and how superior this simple strategy is) but then fails to provide any substantial amount of information. There seems to be an "unabridged version" which might have some meatier information, but this CD was extremely wordy to make a simple point.
There were perhaps just a few bullet points:
you want to compare companies by their earnings yield or % earnings per dollars invested.
you should expect to earn a greater return than low-risk investments, such as held-to-maturity treasury bonds.
you should be careful because some companies destroy value when they expand.
earnings can be volatile.
prices of stocks can be extremely volatile.
The first point and last point are his main points. Obviously, you want to buy a company you think will continue to have solid earnings, but whose price has sunk during market volatility, and hence you get a bargain. You look at a company's earnings yield, to tell whether it is a bargain or not. Does it get a 10% return on capital while another stock gets only a 2% return on capital?
The story he uses is really long and lame for anyone older than 18. (again: the unabridged version might be meatier, as might the book)
One big thing he doesn't expound upon is what time frame are you looking at, for earnings? Presumably last 4 quarters.
Others prefer to go upon analysts' expected earnings for next year. I haven't figured out how much more reliable using those figures are than past earnings, but I hope I can figure that out.
Some other reviewers of the book talk about EBIT. The audio CD doesn't go into different measures of earnings (dividends vs NI vs EBIT vs EBITDA) or dollars invested (common stock value vs enterprise value). The audiobook also doesn't explain why some high-growth company's have extremely poor earnings yields (like Amazon) which is b/c people are anticipating/speculating that at some point in the future it (after it has established so much market-share and well-developed products and product-spaces and infrastructure) it will be able churn out big earnings. Clearly, he advocates finding companies that are "bargains". However, he doesn't warn you about "value traps", where a company occasionally has rapidly declining earnings, but the company is a bargain based on past earnings. Good examples would be a company whose few patents have expired, its mineral resources have been depleted, or its technological product line is at a dead-end (1990s' wordprocessors or CRT monitors, for example) without a modern successor.
Back to the issue of growth stocks, there is always the hope that the company's assets (tangible and intangible, book and non-book) can far outlive their book depreciation expenses which dock earnings in their periods of rapid growth. For example, Google, according to one article expenses all its software R&D costs the year it incurs them, instead of capitalizing them as assets and depreciating them over time. This potentially means that future earnings might benefit from software product segments that have greatly reduced future development/maintenance costs. If competitive pressure is too great than this may never actually happen, and the company might always struggle to make earnings.
The risk of growth stocks is that there is much speculation about how much future earnings the rapidly growing company might be able to churn out in the future. This is not so easy, b/c sometimes competitive pressure forces margins to stay ultra-low or even force them to become unsustainable. I am still looking for a good book that will explain all these nuances in greater detail. I am starting to chew on Damodaran's books and the Wiley CFA series, as well as some Buffet books, and I recommend others to likewise.
Greenblatt uses his own version of the earnings yield and return on capital formulas, and excludes financial, utility, and ADR equity. This makes applying the screen to stock research websites difficult, but fortunately the author has brought up his own customized (if rather Spartan) website.
I wish there had been a little more meat, but overall it was worth my time and money.
First off, there is merit to any criticism of a math-driven investment strategy that is derived by determing that it would have worked well had it been applied in the past. Second, the point that this strategy actually is quite difficult to implement yon your own without Greenblatt's website (which may or may not remain free or in existence in the future) is also true.
That said, this book trancends those very real problems in its accomplshment of its stated goal. To begin with, this book can be read and understood by fairly young kids, which is impressive (you try explaining the absract world of investments to young folks, trust me, it's hard). More than that, however, the investment strategy Greenblatt lays out in this book is fundamentally sound. Furthermore, Greenblatt's convincing argument around the idea that you need to stick with this strategy (or any other for that matter) through good times and bad is an important idea lost on most investors these days.
The flaws keep this book from being five stars, but its good attributes weigh far more heavily. Recommended reading.
Top reviews from other countries
If something is so simple and effective, it would be used by a lot of people; and that itself should reduce its effectiveness. However, Joel Greenblatt explains why majority of the investors cannot stick to the formula, and therefore, it will continue to remain effective for those who can invest according to the Magic Formula for a long term.
From the reasoning described in the book as well as the credibility of the author himself on account of his exceptional investment track-record, it seems convincing that the strategy should work. However, the only way to know whether it will work or not is by putting it to use for a long term. Alternatively, the investor can simply take the learning from the book that high RoCE and Earnings Yield are the two most important factors while analysing a stock, and give high importance to these two factors while selecting individual stocks for investment. But it is a well known fact that it is extremely difficult to beat the market by selecting stocks individually. The reader is reminded of this fact by the author.
Anyone interested in building his/her own stock portfolio should consider this book.