385 of 419 people found the following review helpful
on December 23, 2005
As a portfolio manager at a large New York based hedge fund I have read more investment books than I care to admit. With that being said, The Little Book That Beat the Market is the first book I have felt compelled to review on Amazon (of course, I am not really going out on a limb recommending a book that legendary investor Michael Price describes as "One of the most important investment books of the last 50 years.")
Professor Greenblatt's first book, You Can Be a Stock Market Genius, is widely regarded as the seminal text on special situations investing and the strategies contained in the book are employed by multiple hedge funds and investment professional. While I recommend Stock Market Genius to anyone who has the time and desire to analyze stocks in detail (at least 3 hours a week) I highly recommend The Little Book That Beat the Market to ALL investors of ALL ages and to ANYONE who wants to understand how businesses create value.
The beauty of the Little Book is a follows:
1) It is simple
2) It works
3) Most investment professionals cannot follow the Little Book's strategy and that makes this strategy one of the only instances where small investors have a HUGE advantage over professionals.
4) The people who have recommended this book are some of the most successful investors in the history of Wall Street (myself excluded, maybe someday!)
1) It is Simple
While some of the reviews on Amazon have argued that the Little Book is too simply, I completely disagree. The reason this book is great is that it takes a very complicated subject matter (investment success) and makes it simple and easy to understand. Bottom line, I don't really care if something is difficult or easy, if I can use it to make money I like it. The fact that the Little Book works AND it is easy, is really the best of both worlds.
2) It Works
The actual results of the Little Book describe in the book are astonishing. While I agree with others that reproducing the exact results of Professor Greenblatt's study is difficult for non-professionals, using Compustats real-time database gets remarkably close to the results described in the book and detailed on his web site.
However, what I find to be more valuable than the results themselves is Professor Greenblatt's explanation on why the formula works. Yes, everyone wants to buy cheap stocks but understanding how to distinguish between which cheap stocks are just cheap and which are good businesses worth owning is critical to investment success. While these concepts might not be entirely new (Warren Buffett writes about them annually), never before have I seen them described so completely and simply in one place.
3) Most Professionals Can't Follow Strategy
Most investors (especially hedge funds) are monitored closely on yearly, quarterly and monthly performance. For a hedge fund, having stable monthly numbers is considered critical to attracting new capital and preventing redemptions. Despite the fact that the Magic Formula has excellent long-term performance (30% annually over 17 years) the monthly volatility (down 5 out of every 12 months on average) makes it impossible for most hedge funds and professional investors to follow strictly without fear of investor redemptions. As a hedge fund manager I plan on incorporating the concepts of the Little Book into my investing but I am establishing a fund for my children that will invest strictly based on Professor Greenblatt's Magic Formula.
4) Recommended by Highly Successful Investors
As I stated above, I am not really putting myself out on a limb recommending a book written by Professor Greenblatt (his 20 year track record of 40% annual returns speaks for itself) and endorsed by Michael Price, Andrew Tobias, Professor Bruce Greenwald, Michael Steinhardt, the Wall Street Journal and the Financial Times.
With that being said, I highly recommend The Little Book that Beat the Market and believe it is a great read for anyone interested in investing and business. FYI, other investing books I highly recommend are The Essays of Warren Buffett: Lessons for Corporate America edited by Lawrence Cunningham; The Intelligent Investor, by Benjamin Graham; Margin of Safety by Seth A. Klarman; Value Investing with the Masters by Kirk Kazanjian and Money Ball by Michael Lewis.
99 of 105 people found the following review helpful
on August 15, 2006
Joel Greenblatt's Little Book That Beats the Market (John Wiley, just released; $19.95), offers what the author says is a "magic formula" for success in the stock market. Such a phrase may arouse your skepticism, as it did mine, but let's look into the claim.
Joel Greenblatt founded and is a managing partner of Gotham Capital, a hedge fund that, according to reports, achieved a 50% annualized return [before payment of an incentive allocation] during the ten years (1985-1995) that it was open to outside investors. This kind of record certainly merits attention. Greenblatt, it's safe to say, has gotten rich.
Greenblatt's formula is based on only two measures: earnings yield and return on capital. These numbers are not hard to obtain. Greenblatt defines earnings yield as EBIT (earnings before interest and taxes) divided by enterprise value. Enterprise value equals a company's stock market capitalization plus debt plus preferred shares minus cash and cash equivalents on the balance sheet. Return on capital he defines as EBIT divided by the sum of net fixed assets (total assets minus depreciation to date) plus net working capital (current assets minus current liabilities).
One weakness of Greenblatt's presentation is the use of earnings as a measure. I prefer to look at a company's free cash flow (after subtraction of capital expenditures) rather than EBIT. Earnings are susceptible to a greater degree of manipulation than cash flow.
Second, the book does little to elucidate the qualitative measures that go into Greenblatt's investment process. Which businesses have a sustainable advantage? How do you identify growth? On the other hand, Greenblatt lays out a testable hypothesis--a real merit.
If you are interested in pursuing Greenblatt's idea's further, I recommend you visit his Website on MagicFormulaInvesting. At that site, you define a minimum capitalization size and a target number of stocks for your portfolio. The magic formula spits out a suggested investment set. A good number of the selections at present are in the areas of pharmaceuticals and technology.
Greenblatt presents some impressive numbers illustrating the back-tested historical results of his approach. These are, as the saying goes, no guarantee of future performance. The more money that follows Greenblatt's approach, the less it will return, over time. However, since Greenblatt's approach has a rational basis, you might also see a more rational allocation of capital to investments, which could reduce their volatility. By the same token, one rarely sees bargains anymore of the sort that Benjamin Graham outlined in Security Analysis (1st ed., 1934)--whereby companies could be bought for less than their net current assets--and the market is better for it. In that sense, financial theory is right in predicating that there is no "money machine" that markets--that is to say, competing investors--will not seek to arbitrage away.
(The author of this review, Andy Szabo, is founder of MindBodyForce.com)
333 of 372 people found the following review helpful
on January 2, 2006
I won't repeat what other reviewers have said. This book is a quick read, with a breezy tone, and in some simple ways helps to explain value investing, but...
A few problems that the author dismisses without any discussion.
1. Backtesting. Most backtested stock market systems don't work in the forward direction for very long. A good example is the Motley Fool's Foolish Four model, based on the Dow Dividend model. Backtested it looked great! But when a large number of people started to follow the model, it's performance approached mediocre. This makes sense. Wall Street is nothing but efficient. Any strategy that works will quickly be copied by tens of thousands of players, and this can quickly ruin a system. That's why hedge funds that use "black box" models don't publish the models.
And since Greenblatt tells the reader that the system only works over a three year period, it would be at least three years before one could tell the system wasn't working.
I would predict that the system will produce diminishing returns over the next ten years, proportionate to how many copies of the book that the author sells. Ironic that the richer that Greenblatt gets, the poorer his followers will get.
2. Trading costs: Greenblatt completely ignores trading costs and taxes in his analysis. If you follow his advice and buy 30 stocks, you would pay $779 in round-trip commissions at E-trade (or $600 if you had more than $50,000). That's about 1.5% a year in trading costs on $50,000 invested, or about 3% a year on $25,000. Or almost 8% on $10,000! That's a big expense drag, especially if the system doesn't outperform by as much as it claims to.
And taxes. If you do this strategy in a taxable account, you would incur another 15% to 25% hit in the form of capital gains taxes and state taxes, depending where you live. Thus the cost of the strategy could add up to as much as 33% a year in a state like New York or California. Again, very hard to make money this way, unless the strategy beats the market by 100% as it claims. (Of course, in a tax-deferred retirement account, this would not be a problem.)
The alternative, investing and holding a diversified by asset type group of index funds, would have a yearly cost of less than 0.3 % a year, and would generate little or no taxes until sold many years later.
3. Being hostage to his website, which is carefully labeled "free for now." Because his formulas don't translate well to free financial sites, the user of this system will have to depend on the generosity and fairness of the author. What if you start to use them system, and two years from now the site becomes an expensive pay site? That just adds another expense, and each expense becomes a drag on performance.
4. Dubious endorsements. So what if the publishers got rave reviews from famous investors? This doesn't mean that the book has any merit. I'd like to ask each of those investors if they plan on replacing their own investing style with the author's system.
5. No analysis of risk-adjusted returns. A basic principle of investing is that you get paid for risk taken. Thus small stocks, which are riskier, tend to return more over time. Riskless assets such as treasury bill will tend to yield low returns.
I'd like to see risk-adjusted performance data. For instance, what is the Sharpe ratio of the stocks picked by his system? What are the standard deviations? What are the beta's? If the system really is good, then it should look good on a risk-adjusted basis. The interested reader might want to take a look at William Bernstein's excellent The Four Pillars of Investing : Lessons for Building a Winning Portfolio if they want a thorough understanding of risk and return.
I'd also like to see a better attitude from Mr. Greenblatt on his website. Amazon reviewers are a serious, thoughtful group for the most part, and perhaps responding to some of the issues raised in an open way would help readers and potential readers of his book to understand it better.
I guess I'd like to conclude by reminding everyone of the standard investment disclaimer..."Past performance does not guarantee future performance in any way."
71 of 78 people found the following review helpful
on January 4, 2006
After reading all the reviews here that span the entire range from totally worthless to the best investment book ever written, I felt compelled to add this. I work on my own investments full time, have read over 25 related books including the classics, and always felt there was still a big void where the average investor was concerned... the one targeted by what I feel are unscrupulous marketing campaigns to separate them from their money. As one example, David Swensen, the Yale Chief Investment Officer in charge of the Yale endowment, recently wrote: "The mutual-fund industry sits at the center of a massive market failure. The asymmetry between sophisticated institutional providers of investment management services and unsophisticated individual consumers results in a monumental transfer of wealth from individual to institution."
Greenblatt is a very experienced and successful long-term investor who knows what he is doing in this profession. He did not write this book for his peers. If you are managing money, you have your own methods, and if successful you are not about to change them. That's not Greenblatt's intent. His intent is clearly to try to brush away some of the excessive complexity and confusion and outright fraud that has been foisted on the general investing public ever since Modern Finance rose to prominence and investment firms' marketing departments, not their investment results, became their sales drivers.
What Greenblatt has accomplished in just over 100 pages is:
1) An understandable explanation of what one useful way to identify a quality business is (ROIC)
2) An easy way to identify how to buy such a company at a good price
3) How to manage a real portfolio with this strategy
4) How to remove emotion and poor judgment from the investor's actions
5) A short introduction to the statistical historical performance of this strategy, mentioning the typical pitfalls of data mining and backtesting and how he avoided them
None of these topics, especially the more technical ones, are treated in such detail that the intended reader would be confused or turned off by it. This could certainly be seen as a negative for some (but a positive for most, I would venture). It might be better to have these in gory detail in an appendix or on the web site. Here's hoping such information appears, and this is the only reason I did not give the book 5 stars.
I would especially like to highlight the importance of 3) and 4) listed above. It's one thing to come up with a list of stock picks. It's entirely another thing to translate that to managing a portfolio where buy and sell decisions need to be made. Eliminating emotion and judgment (which, for most investors, are usually their biggest causes of failure) is a very important part of this strategy and is the reason behind buying all the stocks (no analysis allowed) and the strict one-year hold period. Sure, it would be great to let your winners run and losers be cut, but that introduces judgment, and most investors will fail if so.
When reading these reviews, the reader should firmly keep in mind who the intended audience is. It's not the investing professional, not the quant, not the day trader. It's your average person of average intelligence who wants to do better at investing their assets than the other options that are practical for them (most of which are rather poor). This is the first book I have ever read that gives this average person the confidence to do that through specific methods that are easy to follow. I plan on giving a copy to at least half a dozen family members and encouraging them to use the method.
137 of 155 people found the following review helpful
on December 12, 2005
To make such claims of outperformance without verifiable proof is irresponsible. I was looking to backtest this strategy, but after reading the book and checking the website I am unable to back into either EBIT/EV (which should be very easy) or ROC (also very simple). There is simply not enough detail to match the calculations on the site (which is based on the book). They claim to be using Compustat's point in time database which I have access to. Are they using twelve month trailing numbers, projected numbers, most recent quarter, or something else? Perhaps there is a transform applied to the ratios, we just do not know. There are not answers to these questions in the book anywhere.
Take Callwave (CALL) today (12/12/05) which is on the sites list as being recommended today. CALL has a Earnings Yield of 16% as calculated by Greenblatt's site. The little book describes EV = Market Value of Equity Including preferred + Net interest bearing debt. Though most in the industry also subtract off cash, it turns out that I am unable to reproduce their numbers either way.
Since CALL does not have debt or preferred stock or minority interest then EV should = Market Value = 104.64. To get an Earnings Yield of 16% EBIT must be 16.74.(If you subtract off cash EV = 104.64-61.9 = 42.74, so for a 16% EY EBIT must = 6.84)
According to COMPUSTAT (period ending 9/05):
Trailing 12 months EBIT = 8.5
Most recent Quarterly EBIT = 1.8
Most recent year-end EBIT = 9.5
Added Notes: The book's web site [...] mentions this review. Instead of responding to this note why not just provide specific step by step calculations. Why not start with CALL and show us on your website which data items you use and the calculations. I would think this is in the interest of all, especially if this 'magic' formula is so easy. Then others like myself with equally high quality data can validate your results.
Skip this one and read Benjamin Graham.
73 of 81 people found the following review helpful
on January 15, 2006
Whether or not you intend to invest in the market, Greenblatt's book is a great read -- easy to read with lots of tongue-in-cheek humor. If you do invest in the market, it's got some good ideas, but there is a problem that one other reviewer already noted with Greenblatt's Magic Formula. (I wanted to abbreviate it as MF hereafter, but realized that could have other connotations. So please forgive the repetition.)
When I went to Greenblatt's web site and got a list of stocks that the Magic Formula indicates should have above average returns, 24 out of 25 had Returns on Invested Capital (ROIC) of >100%, and the other one had 75-100% listed. These seemed outrageous, even wrong, to me at first. And like the other reviewer, I wondered what was going on.
Some thought and a conversation with a friend who is a (very good) retired CPA solved the mystery. Some industries, notably software, require very little capital, especially if they rent their equipment, space, etc. Their real capital (not counted in the Magic Formula) is their people. With very little monetary capital on their balance sheets, they can have a ROIC that is well over 100%. But that is not a good indicator of their ability to grow since their real capital, excellent people, are in limited supply.
So the Magic Formula is biased toward industries like software that have low capital requirements, and away from heavy manufacturing industries with their high capital requirements. And during the period 1987-2004 that Greenblatt uses to verify the efficacy of the Magic Formula, software (and probably other service type industries that have low capital requirements) did much better than heavy manufacturing. This puts his comparison to market averages, like the S&P500 into question. If as I suspect, the Magic Formula had a significant bias toward certain industries, a better comparison would have been to a market average weighted according to industry, with the weights equal to the proportion of Greenblatt's portfolio in each industry.
There also is a bias against companies that are viewed as growth companies since they will rank far down the list on earnings yield (basically the inverse of P/E) -- the second component of the Magic Formula. That doesn't seem to be much of a problem and may be one reason for the Magic Formula's success. It tends to pick contrarian stocks.
This isn't to say that the Magic Formula won't work, just that the comparison to broad market averages is probably not a good indicator of how well it works. I may still use the Magic Formula to help me find stocks to consider investing in, but I think it may be dangerous to blindly trust the Magic Formula as the book suggests since low capital industries might underperform in the future.
67 of 75 people found the following review helpful
on December 28, 2005
The author has created a very simple factor model that only looks at two variables. Nothing wrong with that - in backtesting, simplicity is your friend. Unfortunately, it also makes it far easier for others to duplicate. Greenblatt sites the excellent work done by Robert Haugen in the area of factor modelling. Indeed, it was excellent, right up until he published it. Then it went to hell. And Haugen's work was far more difficult to replicate, but nonetheless lots of hedge funds did just that.
Greenblatt says his model is different, though, because it isn't likely to be copied by the pros because the approach underperforms for extended periods of time. This is a nice try, but it won't stop most hedge funds. They will likely blend the strategy with other non-correlated approaches and thus create a smooth return pattern. Most managers know that any strategy worth persuing is going to have stale periods.
He also says that the model is out of reach of many of the pros because it gets its best returns from stocks too small for the big boys to touch. In mutual fund terms, sure, but what will kill this are, again, the hedge funds, and there are lots and lots of small hedge funds that can easily buy stock with $100 million market caps.
Sadly (from the money manager's point of view) we live in a more efficient world where backtests, particularly ones thrown out there in a catchy book, will prove to be mere phantoms.
One other gripe: it would have been nice to see more data. We really don't get anything but annual returns. No examples of actual trades or stocks are given.
I do applaud the author for using a writing style that demystifies. Much of the prose in this area is intentionally abstruse and wooden.
33 of 36 people found the following review helpful
on February 13, 2006
It's not that long of a book, ~150 pages. Make sure you read the whole thing though, including the appendix. I'm reading various reviews criticizing how Greenblatt ignores transaction fees and taxes, that his strategy is the same as Morningstar, and that this is merely backtesting. None of these are true. He addresses these issues clearly.
1) For investors with little capital, to avoid piling up high transaction fees, use a broker with an annual or monthly flat trading fee, such as foliofn.com. Not to promote the site or anything (it was mentioned in the book), but $19.95/mo. or $199/yr. for unlimited window trades seems within reason for almost all investors.
2) Effects of taxes are significantly reduced by employing Greenblatt's indicated method of selling losers 3 days before 1 year to maximize deductions and selling winners 3 days after 1 year to minimize capital gains taxes.
It is important for everyone to consider the effects of taxes on investments, but to defend Greenblatt in his failure to write a "Complete Guide to Investment Taxes," I'd say that was not the purpose of this book. The purpose was to endow on willing readers a basic understanding of value investing with clear, simple examples and provide a sample strategy that can actually be successfully employed.
3) The measures that characterize degrees of bargain and quality/profitability for companies are beefed up in the Appendix and on the web site, maintaining the basic idea with a more accurate and applicable formula to today's publicly traded companies. So, P/E and ROIC, being somewhat overly simplistic, are not actually the measures used for their screening engine. Rather, the measures are expanded to include such factors as debt, assets, etc...
4) You will have to take his word for it, but Greenblatt clearly states that the approach was devised from the ground-up, i.e. not from backtesting and data mining. In fact, he strongly condemns these practices throughout his book.
Please read the book before writing reviews.
45 of 51 people found the following review helpful
on January 25, 2006
"Catablast" (Dec 4 2005 reviewer) didn't read the appendix. Greenblatt employs subtle, non-standard definitions for return on capital and earnings yield. For anyone seeking a better definition of intrinsic value, this is the interesting part.
I skimmed quickly through the body of the book, and have been mulling over that appendix ever since. The book was worth the purchase price just for that.
Greenblatt's associated stock screening website, mentioned in the book, has a few problems, but is still worth using.
For example, in early January 2005, the site listed CBS Corporation as a good pick. However, their reported ROC and EY were way, way off. I wrote them to point this out. No reply, but CBS disappeared from the site less than a week later. During that time there was no change in the CBS price or financial information, so the only conclusion is that they realized the error.
It was more an effort of omission than commission, most likely. Their list depends upon accurate information from Compustat. After a spinoff, particularly a reverse spinoff like CBS, data services like Compustat occasionally report inaccurately for a while. Garbage in, garbage out.
This does not make the formula wrong. It means that, before investing, you should double-check the data upon which the formula's results are based.
209 of 251 people found the following review helpful
on November 30, 2005
This fine little book is a significant contribution to the market philosophy known as Value Investing, but unlike other value investing books, Prof. Greenblatt offers readers a simple yet effective formula for finding good companies and great prices, he also demonstrates the 'most satisfactory' (as Ben Graham might have put it) historical returns that this 'magic formula' yielded over the last 17 years. His methodology is sound, to be sure, though one quibble here is that some of the stocks thrown back using his screen are clearly one-hit wonders: specialty pharamceutical companies whose future earnings are surely questionable.
However, the beauty of Prof. Greenblatt's formula is that it can be scaled up or down in terms of diversification as a 'hedge against ignorance' (as Mr Buffett might say). While still relying upon the magic formula, more sophisticated investors can take a more active, focused approach to their 'magic' portfolio, screening out likely dogs while remaining true to the overall strategy. Contrariwise, less sophisticated investors are advised to diversify broadly to hedge against the dogs in their portfolios.
The key to the approach, as with all value investing approaches, is time, time, time. Patience and discipline are the first virtues of value investing, and must be practiced with jesuitical commitment for this strategy to work. Buffett and Graham didn't make billions day trading, and neither will magic formula devotees. But you must be patient grasshoppers! Highly recommended read.
(to underscore the importance of patience in this approach, I thought it interesting to note that only 2 of the top 50 cos on a Goldblatt's screen I ran were rated '2' or above for timeliness in the Valueline investment survey; and 27 of the 50 weren't rated at all, owing to the fact that they were microcaps.)