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The Little Book That Still Beats the Market Hardcover – September 7, 2010
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While the formula may be simple, understanding why the formula works is the true key to success for investors. The book will take readers on a step-by-step journey so that they can learn the principles of value investing in a way that will provide them with a long term strategy that they can understand and stick with through both good and bad periods for the stock market.
As the Wall Street Journal stated about the original edition, “Mr. Greenblatt…says his goal was to provide advice that, while sophisticated, could be understood and followed by his five children, ages 6 to 15. They are in luck. His ‘Little Book’ is one of the best, clearest guides to value investing out there.”
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.
In Chapter Two, author Joel Greenblatt discusses how you can start saving and growing your wealth [PDF].
Top Customer Reviews
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.Read more ›
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.Read more ›
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.Read more ›
Most Recent Customer Reviews
It is important to know is happening in the market from an specialistPublished 14 hours ago by Jose G Cervantes G
Very easy to read and understand book about investing, but with actionable items that can help build out a portfolio -- IF you buy into the strategy!Published 1 day ago by James A.
This little book is phenomenal! It really simplifies the process of value investing by describing a system that the author calls the Magic Formula. Read morePublished 15 days ago by Chris H
A classic entry level book for a value investor. Recommended.Published 1 month ago by Swapan Munshi
I think this is pretty good to read. Value investors show that with quite simple valuation and discipline you can create solid results. Read morePublished 1 month ago by Amazon Customer