396 of 437 people found the following review helpful
An Easy Quick Read, Some Good Points, Some Big Problems,
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This review is from: The Little Book That Beats the Market (Hardcover)
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."
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Showing 1-10 of 19 posts in this discussion
Initial post: Jun 16, 2008, 2:50:45 AM PDT
S.D. Souza says:
You start off by saying backtesting doesn't work but your reason is that it's because too many people start adopting the same system? What does that have to do with the efficacy of backtesting in the privacy of your own home, like 99% of us do? Your point is very unclear.
In reply to an earlier post on Oct 26, 2009, 10:43:59 AM PDT
Amazon Customer says:
What he meant was that back-testing is not a SUFFICIENT test.
Posted on Mar 26, 2010, 5:06:16 PM PDT
Last edited by the author on Mar 26, 2010, 5:07:55 PM PDT
It's March of 2010, and the website is still free. I have caveats as well. I think no system is perfect and the author tries to simplified his approach to the general public. If 30 stocks per year is not a feasible approach, then one will have to do their homework pick out of the 30 stocks or 50 stocks.
Another caveat is to check your stock price at least every week to look at the trend.
So I wonder if Gottlieb had use the author's formula over the last 3-4 years, what would be the results? Would it be the market?
In reply to an earlier post on Jun 25, 2010, 6:19:58 AM PDT
Donald C. Allen says:
What he is saying is that if you have a method that backtests well and you publicize it, it will work less and less well in the future, as more people jump on the band-wagon. I don't think he is saying anything about some brilliant idea that you might have that you backtest, like the results, and invest in without talking about it, or worse, writing a book about it.
I saw Greenblatt interviewed by Steve Forbes and he was asked about this -- why should we expect this to work in the future, since a book has been written about it. Greenblatt's answer struck me as hand-waving, very unconvincing.
Posted on Dec 25, 2010, 6:34:44 AM PST
Dennis M. Campbell says:
I concur with the excellent analysis of Mr. Gottlieb. I would add that the system makes no provisions for sector diversification. All the recommended stocks might be in two or three industries, which would produce a tremendously volatile portfolio.
Posted on Aug 2, 2011, 6:05:49 PM PDT
Meir Ben David says:
I think that he answered why he doesn't use beta in his analysis. I believe he wrote that risk measures taken up by most academicians should make no sense to the general public. Warren Buffet also said something about this. He said that to an academician, the history of stock price is gold as it produces beta. In his opinion, it allows academicians to be very precise. However, it is better to be approximately right than precisely wrong. This has been the position about risk measures taken up by many value investors. Risk is in price volatility only if you need to take your money out tomorrow and need to make sure that it's there. For most other investors in stocks, risk is better measured by the prevention of permanent loss of invested capital. For example, if anybody knows, what was the beta for Lehman Brothers in 2008 the day before they went down? Was that a good measure of risk? I recall that many brokerages were still recommending it after it already declared bankruptcy. This is why value investors, of which author is one, do not trust modern portfolio theoretic measures of risk.
In reply to an earlier post on Aug 2, 2011, 6:19:47 PM PDT
Meir Ben David says:
Would the fact that constructing the formula based on an idea that makes sense to you and then finding out that it actually works on historical data be sufficient? My criticism of the author's work is that he uses only 10 years worth of data rather than, say, 50 years' worth.
I personally think that conducting mental experiments to construct theories that can then be verified or falsified is quite OK. What doesn't work is randomly selecting patterns until you find one that works, but can't explain why it should work.
Posted on Sep 5, 2011, 1:53:50 PM PDT
Last edited by the author on Sep 5, 2011, 1:54:23 PM PDT
Amazon Customer says:
Regarding #4, I know personally that one of the big name endorsers of this book not only recommends Joel's approach at every opportunity, and believes strongly in it, but also just invested a very significant sum in Joel's new mutual funds (the Formula Funds). Not only that, but he thinks there's a good chance that his investment with Joel outperforms his investment with me over the next five years. Now, he's seriously mistaken about that latter part :-), but I can tell you that the big names cited here really believe in Joel's method. I'm not a big name, but I am an investment professional who has performed well, and reading this book a second time this year changed some of my investment techniques for the better. It's AWESOME that an excellent hedge fund manager (Joel Greenblatt) has tried to democratize investment success.
Posted on Jan 2, 2012, 2:21:06 PM PST
Last edited by the author on Jan 2, 2012, 2:27:56 PM PST
Doris Gets Her Oats says:
The backtesting argument is very common and logical but ultimately based on a false premise: if it works so great everyone will do it and therefore stock prices will rise and fall as the giant herd of value investors all seek out the same stocks. But that's not how it works in reality. The best evidence of that is Warren Buffet. He's addressed this many times, chuckling at the idea that the market is super-efficient. One argument he's made that seems to make a lot of sense is that many people just don't get it. The tech heyday of the late '90s to March 2000 was possible because few were daunted by huge P/E ratios and no profits (anathema to value investors)--to the contrary, they were seeking out huge P/Es and gobbling up what they dreamed were future Ciscos. That these folks got burned hasn't changed that mentality. What makes the Benjamin Graham method work (as it is repackaged here by Greenblatt) is that it's counter-intuitive. By moving against the brainless herd that, i.e., sent AMEX to $12 in 2009 (now in upper 40s), or ignored Domino's Pizza that same year sending it as low as $6 (now mid-30s), people can make a lot of money. Bad things happen to good (proftable) companies. That's never going to stop. The market isn't efficient but panicky and irrational, and therein lies the opportunity for profit. It's like golf. Everyone knows at some level that a nice easy compact swing will make the ball go far and straight, but that doesn't stop 99% of us from trying to destroy it like Tiger Woods.
Posted on Feb 2, 2013, 10:44:40 AM PST
Last edited by the author on Feb 2, 2013, 10:50:29 AM PST
Regarding backtesting, I think that when an investor puts together a portfolio of his/her stocks, the investor does it based on the current Mr. Market offers. If previous value investors had bid up certain stocks, the current investor would not consider those stocks in his/her portfolio. However, if we have a crazy overvalued market, with most companies trading at exorbitant P/Es (see AMZN), then most investors are bound to lose money once Mr. Market returns to sensible P/E valuations.