The Little Book that Beats the Market | Joel Greenblatt | Talks at Google

[Music] Joel greenlot Our Guest for today is the co-founder managing principal and co-cio of Gotham Asset Management we could not be more thrilled and more grateful than to have him accept our invitation and be here thank you so much y over to you thanks so much thanks for coming out today I really uh appreciate it very much uh never been here before so I'm looking forward to my tour right after so thank you uh so even Warren Buffett says uh the vast majority of people should index and I agree with him so are there any questions or do I have any time then again I get well I have time so uh then again you know Warren Buffett doesn't index and neither do I so I thought I'd tell you why uh and then maybe you'll have some more information to decide for yourself what makes make sense for you and in a sense it shouldn't be that

hard I actually I had a friend uh who's an orthopedic surgeon and is in charge of a a group of orthopedic surgeons and he asked me to uh speak to them at a dinner uh about the stock market and I said okay these are smart educated guys they can understand this stuff and I uh spoke for about 35 minutes explaining how the stock market worked and everything else and then I started getting questions uh along the lines of oil went down $2 yesterday what should I do or Market was up 2% yesterday uh what do I do about that so my interpretation to those questions was I had just crashed and burned so uh last year uh I was lucky enough to be asked to teach a nth grade class uh a bunch of uh kids uh mostly from Harlem and I had just sort of Crash and burned with the orthopedic surgeons and I didn't want to do that with the kids uh and so I started to try to think of what could I do uh to explain the stock market a little bit better uh and so I walked into class the first day uh and I handed out a bunch of 3x5 cards and I asked uh I brought in this jar of jelly beans right here and uh I asked uh the students uh you know passed around the jar jelly beans asked them to count the rows do whatever they wanted to do and write down their best guess

for how many jelly beans were in the jar collected the three by5 cards then I went around the room one by one to each one of the kids in the room uh and I said listen you can keep your guess you can change your guess that's up to you and I went one by one around the room asked people how many and wrote down the the very ious guesses so it turned out the uh guess uh the average of the guesses for the 3x5 cards was 1771 jelly beans uh there are 1776 jelly beans in the jar so that was pretty good uh the guests when I went around the room uh that was 850 jelly beans uh and I explained to them that the stock market's actually the second guest okay because everyone knows what they just read in the paper what the guy next to them said what they saw in the news and uh are influenced by everything around them uh and that was the second guess and that's the stock market the cold calculating guess when they were counting rows and trying to figure out what was going on uh that's actually was the better guess that's not the stock market but that's where I see our opportunity you know once a year in my class at Columbia I uh at least for the last five six years somebody raises their hand and asked a question that

goes something along the lines uh something like this hey Joel congratulations you've been doing this for 35 years uh and you've had a nice record but now there are more computers there's more data there's more ability to crunch numbers and uh kind of isn't the party over for us isn't it just more hedge funds there's just a lot more competition isn't the party over for us so my students are generally second year mbas I'd say average age 27 or so uh so I just answer it this way I I tell them let's go back to when you learn how to read uh let's take a look at the most followed Market in the world that would be the United States let's take a look at the most followed stocks within the most followed Market in the world those would be the S&P 500 stocks let's take a look at what's happened since you learned how to read so I tell them from 1997 uh when they were nine or 10 uh to 2000 the S&P 500 doubled from 2000 to 2002 it haved from 200 to 2007 it doubled from 2007 to 2009 it haved and from 2009 to today it's roughly tripled which is my way of uh telling them that people are still crazy that was just the last 17 years uh and I'm way understating the case uh because the S&P 500 is an average of 500 stocks if you lift up the covers and look underneath

what's going on there's huge dispersion of those 500 stocks between those at any particular time that are in favor and those that are out of favor and so there's a wild ride going underneath the covers if you look under the covers a wild ride of those 500 stocks at any particular time and that doubling and having doubling and having with the average of 500 stocks really smoothing the ride so there should be uh an opportunity and uh if you understand what stocks are and I uh guarantee my students first day of class uh I make a guarantee every year they walk in and I guarantee them this if they do good valuation work I of a company I guarantee them the market will agree with them I just never tell them when could be a couple weeks could be two or three years but if they do good valuation work the market will agree with them stocks are not pieces of paper that uh bounce up and down you put uh complicated ratios on like sharp ratios or Cino ratios stocks or ownership shares of businesses that you are valuing and if some inclined tried to buy at a discount so if you believe what Ben Graham said that this horizontal line is fair value and this wavy line around that horizontal line are stock prices and you have a disciplined process to buy perhaps more than your

fair share when they're below the line and if someone cined sell or short more than your fair share when they're above the line the market is throwing us pitches all of the time uh the reason people don't outperform the market there are behavioral problem there are Agency problems but it's not because we're not getting those uh opportunities uh I will show you uh briefly let me tell you how we value stocks uh it's not very tough and I think most of you will understand it uh and I think the best example that resonates seems to resonate with most people is uh thinking about buying a house and to keep the number simple let's say that someone is asking a million dollars for the house they want to sell and your job is to figure out whether that's a good deal or not so there's certain questions you would ask first one of the first questions I'd ask ask is well how much rent could I get for that thing okay so in other words if I rented out that million doll house how much rent would I collect if I uh were going to collect 70 80 $90,000 a year 78 9% yield on that house that's one way I might go about valuing it and what's the next question you would ask I'm pretty sure I know what it would be uh what are the other houses on the Block going for

in the block next door in the town next door how does this compare how relatively cheap is this relative to all my current choices so that's what we do we look at how relatively cheap is this business relative to other similar businesses relative to a whole universe of choices that I have we do that we also go back in history look at how this company or uh this house has traditionally been valued versus other ones in the neighborhood or versus uh other communities and how is it being valued now so measures of absolute and relative value absolutely cheap you know on a rental basis absolutely cheap or relatively cheap on all different kinds of measures that that make sense to you now you wouldn't use any of these measures all by themselves if you just use relative cheapness uh if some of you remember the internet bubble and you bought the cheapest internet stock that wasn't cheap it was just cheap relative to all the other crazy priced uh stocks at the time but we use our we use our measures of absolute relative values checks and balances against each other to try to zero in on Fair Value so when you do this uh just want to show you a simple chart uh this is actually a study we did

of our valuation methodology very very similar to the way I just said we value uh a house this is how we we looked at the 2,000 largest companies in the US over a 20-year period this was 1992 to 2012 and we ranked them on a daily basis from 1 to 2000 based on their discount to our assessment of value using these metrics the x-axis here you probably can't see it uh is just evalu percentile all this means is if you in the bottom left hand corner and you're in the first percentile you're the 20 companies at any particular time out of those 2,000 that measured cheapest according to our measures of absolute and relative value uh go to the 99th percentile uh you would be the 20 companies that measure most expensive out of those 2,000 the Y AIS is uh the year forward return on average during those 20 years what this chart simply says is on average stocks that fell in our first percentile the cheapest 20 uh averaged a one-ear forward return during those 20 years of 38% stocks that ranked in our second percentile averaged a one-ear forward return of about 37% and then we drop down to this best fit line which we always say we don't mind missing when we're making extra money and then as we measure something more

expensive the year forward return drops and if you were sitting in my class at Colombia and I said hey does anyone see a long short strategy you might pursue if you could predict ahead of time which stocks would do best second best third best in order and you did not say I guess I'd buy these guys up here in the upper leftand corner and short these guys in the bottom right hand corner if you didn't say that I'd probably throw you out of class because it's very straightforward that's what you should do and by the way that's what we do the important thing to understand is that stocks are ownership shares of businesses okay now uh by the way that beautiful chart I showed you with the 90% fit you know why doesn't everyone do this uh well unfortunately it doesn't look like that when you're living through that that's an average over 20 years if I showed you snippet of three or 4 years uh the fit would be nice it might be 0556 something like that but uh it's uh not going to be very Cooperative right if what we did worked every day and every month and every year uh everyone would do it it would stop working but but it uh it it doesn't unfortunately uh but the reason that we stick to what we're doing even when it's not working is that chart meaning the

way we value companies our measures of absolute and relative value or approximately how the market values the over time if we were for instance momentum investors okay and I will tell you that uh for those of you who know what that means uh momentum has been studied uh across the globe over the last 30 40 years in the US it's worked pretty much everywhere uh not all the time but on average it's worked very well over 30 40 years and not just in this country but here's the problem what if it didn't work over the next 2 or 3 years it could be uh that we just have to be patient you know it's it works over time and it's cyclical and so it's out of favor and we just have to stick to our guns because it's something that's worked or it could be if it didn't work in the next 2 three years that the explanation is hey it's not so hard to figure out a stock used to be down here and now it's up here it's got good momentum and with all the data and the ability to crunch numbers and computers and studies that have come out it's a crowded trade it's degraded it's not as is not as uh good as it used to be and if that's what happened over the next 2 3 years I would know the answer to that question I didn't know which one it was should I just be

patient or has the trade degraded but if you view stocks as ownership shares of businesses that you value and try to buy a discount and that doesn't work for a couple years I'm not going to change what I'm do I'm not going to buy the bottom uh right hand corner you know buy all the money losers and the companies uh that don't earn anything or trading it 100 times free cash flow I'm not going to buy those even if it works in one particular year and then sell the ones that uh are cheap relative to everything get me high rents and everything else I'm not I'm not going to change my strategy uh and I believe that uh stocks will eventually not right now but eventually uh people will get it right and I may have to be patient that's really what I have to do what that chart tells me is I'm on the right track meaning that's sort of our true north and we just have to be patient to get there uh the reason that these simple metrics don't get arbitraged away is the example I uh usually used for Arbitrage is uh oh you see gold in New York at $1,200 and and it's selling at London simultaneously at 1201 well an arbiture sitting on a trading desk someplace will see that and buy up gold in New York at 1,200 and push the price

up a little bit he'll simultaneously sell gold in London at 1201 push the price down and they'll convert someone somewhere in the middle and it'll happen so fast on a trading desk that you don't really even get to see that but what if I told you you could buy gold in New York today at 1,200 sometime in the next 2 three years you're going to make money but you could lose 20% of your money while you're waiting there's no guy sitting on a desk anywhere that really uh can do that and and frankly uh time Horizons are getting shorter uh it used to be when I was uh younger I used to get quarterly statements and most people would throw them in the garbage now you can check your stock price 30 times a minute on the internet maybe some of you do uh and time Horizons are shrinking and we're just playing time Arbitrage we're being uh patient buying cheap good businesses and waiting for the market to recognize the value we see uh but it takes some work to Value companies and let's say you don't want to do that you know you have a day job I guess everyone here has a day job so you don't want to do that so one thing you could do is try to find someone good to do it for you right I'm showing you

there's this opportunity maybe someone can do it for you and what you should probably look for when you're looking for that person person is someone who has a good investment process okay that makes sense to you the problem is uh for most active managers uh if you think of their challenge when they're picking an individual stock they must think that they have a variant uh hypothesis as to why that stock is priced differently than the way it should be and I can tell you I've been doing this over 35 years years and it's very rare almost never have I bottom ticked a stock bought bought it at the absolute bottom so 99.9 plus per of the time a stock is down after I bought it and there are really only two reasons why one is I was wrong the other is I just need more time for my thesis to play out okay now as an outside allocator you don't really know what the thesis for the individual stock was even the allocator himself the manager I mean I'm sorry the manager himself sometimes doesn't know when things are going against you there are

all kinds of Agency problems you know you got people to answer to you have behavioral issues just naturally start to doubt yourself it's very unclear sometimes even to them what their biases are and what they're doing you know they did studies that you guys are familiar with probably of why why the home team always wins in sports okay or at least wins more than it should and the original thesis was generally oh they're used to the court they slept in their own bed you know the fans you know they they jazzed them up whatever it might be and when they controlled for all these variables uh the answer turned out to be that the refs don't like to get booed okay so they don't think that they're being biased but uh I'm sure in 99.9% of the cases they don't but they don't like to get food and so they're being influenced by and so this same problem with an active manager he's got agency and behavioral issues uh that he's not uh sure of so the allocator doesn't really understand the thesis behind each pick it's not clear that the manager uh is totally unbiased when he has a variant thesis that's going against him um and so since you don't need know the thesis is an allocator most people uh all they have are the returns and that's what they used so in an

interesting study uh that came out the day after Thanksgiving so it was interesting to me probably not interesting to the guys who did the study uh Morning Star put out a study of their star system and my interpretation uh and their star system is based on past returns letting you know who's done the best over the last one three and five years of course the study my interpretation of their study was that our star system doesn't work uh we can't discern uh the last 1 three5 years of returns has not much to do with the next 135 but that's what everyone uses I wrote a book uh I hold it up here uh it's called the big secret and I always say it's still a big secret because uh no one read it uh and in that book um I talked about a few studies number one uh it talked about the best performing uh manager I wrote In 2011 so talked about the decade 2000 to 2010 looked at the best performing mutual fund a study of the best performing mutual fund for that decade uh that fund was up 18% per year 100% long the US equities Market was flat during those 10 years so 18% up a year is pretty good unfortunately the average

investor in that fund on a dollar weighted basis managed to lose 11% a year because every time the fund uh the market went up people piled in when the market went down they piled out when the fund outperformed they piled in when the fund underperformed they piled out and they took an 18% annual gain and turned it into an 11% annual dollar weighted loss why well to beat the market if you're beating by 18 points you're doing something different than the market you're going to Zig and zag differently you can't do the same as the market you have to do something different you're going to Zig and zag differently uh institutional managers are no different here are the stats on the uh if you just took a look at the top institutional managers for that decade the ones who 2000 to 2010 the top cortile managers the ones who ended up with the best 10-year record here are the stats on them 97% of those who ended up with the best 10year record Top Court tile spent at least three of the 10 years in the bottom half of performance not shocking but everyone right to beat the market you have to do something different you're going to Zig and zag differently 79% of those who ended up with the best

10-year record spent at least three of the 10 years in the bottom cortile performance and here's the stunner 47% roughly half of those who they ended up with the best record but they spent at least three of those 10 years in the bottom desis the bottom 10% of performers so you know no one stayed with them but they ended up with the best record uh so it's very hard uh very hard to pick an allocator because you don't know the thesis so you're using past returns but when you do that all you're doing is chasing your tail going in and out at all the wrong times uh so it's it's very hard uh what a good allocator usually an Institutional allocator and there a few of them should be looking at process and do you stay with your process but of course there's Agency problems on the side of uh those people allocating because even if you're on a really good investment board uh and you're an allocator and you're head of us equities or you're head of uh uh Alternatives or or uh bonds or whatever it might be you have a benchmark and if you haven't beaten your bench Benchmark for the last 3 years I'm not saying you know with the good places they throw you out but I am saying they don't throw you a parade okay so it's very very hard on that so one thing you could do is do it yourself and and I wrote this other book

that you have the little book that beats the market and I just did a simple uh formula that sort of was like the jelly beans counting the rows going across and just picking the cheap companies to buy uh very simple and uh I wasn't running outside money at that time that I wrote the book in 2005 just wrote up the very first study we did of doing some uh something cheap and uh cheap and good businesses just uh made it pretty easy for you to buy a handful of those and uh I kept getting phone calls hey could you just do this for us and so what I did is I set up a website uh that listed the top stocks that's still going around magic formula investing.com uh and people said yeah that's fine but could you still do this for us so I set up something called formula investing and uh I gave people two choices I said uh well I I sort of viewed it as a benevolent brokerage firm I said listen we'll let you do this yourself but you have to choose from this uh top list of 30 or 50 stocks and you have to choose at least 20 of them okay stay out of trouble and you you're supposed to invest every quarter update your portfolio and just you know mechanically do this uh you don't have to buy everything but you have toy buy at least

20 uh and then the uh person uh who was running this for me said you know what how about you just add a check box which said just do this for me just automatically buy so as as an afterthought I said fine we'll do that too so we ran this for a couple years and let me tell you the results uh the people who chose their own stocks you know from the pre-approved list of the top stocks uh they did pretty well for the two years they were up uh 59% roughly unfortunately uh the S&P was up 62% uh during those uh two years uh the automatic you know just do it for me that was up 84% so uh the automatic uh had beaten the uh in other words just buying the list uh had beaten the market by 22 points but by giving people any discretion even though the list was pre-approved just by picking and choosing the ones that uh they didn't like but they had to buy at least 20 they managed to take a 22% outperformance in a couple years which is pretty good and turn it into a a 3% underperformance so do it yourself uh I wrote a I wrote a piece for morning star

called adding your two cents May cost you a lot and uh and uh so I just wanted a caveat that so uh so another way uh let's see I'll do this fast uh I I wrote a book uh s Rob mentioned called you can be a stock market genius world's worst title of all time but uh in it it said sort of what Warren Buffett calls why don't we look for one foot hurdles okay and I opened the book with a story about my in-laws uh who uh used to spend uh they they had a house in Connecticut and they used to spend the weekends going to yard sales and Country auctions uh looking for bargains okay paintings are sculptures they they were uh art collectors uh and uh I described what they were actually doing and they were not going to these yard sales and Country auctions looking for to you know seeing a painting that was discarded saying this guy's the next Picasso that's not what they were doing what they were looking for are uh pieces of art or sculpture that they uh know uh the artist some of his similar work had just gone for auction for a lot more than they could buy it for right they can buy it for 30 or 40 cents on the dollar of what it just went to auction for that's a lot different question and so what you can be a stock market genius

was was showing you these areas that are ignored these are the country auctions and the yard sales of the investment world and these were uh you know I talked about different areas spin-offs bankruptcies uh um you know uh small cap stocks uh you know uh companies going through Rec capitalizations anything weird complicated situations uh so that's another way but you guys have a full-time job that is a full-time job let me tell you that's a full-time job so right now we run mutual funds uh I can just tell you some of the struggles that we have with investors uh we do uh follow that chart uh choose from the 2000 largest companies but the and uh we've had a nice record but there are years like 20 5 where uh there's a benchmarking issue meaning the S&P 500 in 2015 was up roughly 1.3% the equally equally weighted Russell 2000 was down 10 the equally weighted uh weighted Russell 1000 was down four so if you're picking from roughly the 2,000 largest stocks you know uh an even performance would be down six or seven not up 1.3 so there's a benchmarking issue but to beat the market you have to do something

different you're going to Zig and zag everyone knows that uh we're now working on something we've had something open a couple years where we sort of say okay we'll start with the Benchmark and then we'll value ad and we'll make some compromises so that we don't it's called index plus and so that we don't vary uh Too Much from the index so you can stay with us and the thesis was basically the best strategy for you which is how I'll end before I take questions is not only one that makes sense but one you can stick with okay so you have to understand what you're doing number one if you give it to someone else you have to understand what they're doing and you have to be able to stick with it so you have to understand it well enough to stick with it so that's I guess before I take questions what I I uh will leave you at and uh maybe so yeah thank you so much this is great so let me set up some chairs so thanks again in reading your uh magic formula book the little book that still beats the market um I noticed that you mentioned that there were questions about whether one should short stocks the most expensive ones through the same metrics and you had I guess not explicitly said that that's that's the

way you'd want to go and correct me if I'm mistaken and then you started the formula investing funds as well which you uh alluded to in your talk however uh what has happened to them are they still continuing and and what's your vision for that going forward sure we open long only funds called formula investing and we just merge them with our long short funds so we have long short funds that run 100% net long but when we looked at their performance we did better in up markets with the the 100% long long short funds mean we had a long short overlay in up markets and down markets uh pretty much we never did better uh the other way and so we just merged our our simple 100% long into the 100% long that also did long short uh so it was just a matter of trying to put our best foot forward uh and and uh managing the things we we we actually uh we had just been rated the number one fund uh gotten five stars from Morning Star uh for our formula investing fund and we closed it and we merged it with our long short funds uh wasn't really a business decision it was really a a decision that we want to put our best foot forward and uh so that's why that why we did that so when you talk of long

short how do you decide between you know 17070 distribution or 140 40 distribution you know when you're saying you're net 100% long how do you um come at what the ratios should be uh sure so what s Rob is mentioning is that we'll uh what he means is let's say you give us a dollar we'll go buy a dollar of our favorite stocks then we'll go out and uh buy 70 cents more of our favorite stocks but this time we'll pair them with 70 cents of our least favored stocks we'll short them so we'll be 70 long and 70 short uh and so uh so another bucket to add to to add return uh and you know why isn't that 4040 uh we picked uh ratios for most of our funds that we thought made sense given uh how much uh volatility you added by you know the amount of Leverage you're adding and the amount that you're shorting uh there's not a a big magic to it I mean something that worked well at uh dollar long with 7070 or 4040 they both uh work well in our large cap Universe we we give people choices so Joel there are a bunch of questions around the same theme I guess we can sort of package them into one people are curious to know what do you think of the Market's valuation today where do you see value areas today well the benefit of having we have a big research team and and we have a lot of

history on the you know if you want to think of the S&P 500 those 500 companies so we actually go back 25 years and look at each individual company every day for the last uh 25 years and aggregate them in the weights of the S&P 500 so what that allows us to do is go look at today where's the valuation of the S&P 500 today contextualized versus the last 25 years and so what I can tell you is we're in the 17th it's not a prediction I'm just giving you some facts uh we're uh the way we value companies we're in the 17th percentile towards expensive over the last 25 years that means the Market's been cheaper 83% of the time more expensive 177% of the time when it's been here in the past uh year forward returns haven't been negative during that 25 years the Market's been up about 10% a year so uh uh right now from these valuation levels what's happened in the past over the next year Up 3 to 5% on average over the next two up 8 to 10 uh so like I said not a prediction but if you want to know what has happened to stock prices from similar valuation levels over the last 25 years that's what's happened 3 to five uh percent positive return on average over the next year and 8 to 10

over the next two so there's one question around what you were doing in in the first 10 years of investing when I think you average 40 to 50% annual uh gains after fees if if correct me if I'm wrong uh what what was the strategy that you and Rob Ste Goldstein were following in those days and what parts of that are actionable for for the individual investor compared to the index plus strategy you know sure so Stock Investing is figuring out what a business is worth and and paying less and so that hasn't changed what makes a company uh worth something and what makes it cheap relative to that it's pretty straightforward uh we're sort of you know that's sort of Ben Graham figure out what it's worth pay a lot less leave a large margin of safety between those two uh Warren Buffett added a a little twist that made him one of the richest people in the world uh he simply said if you can buy a good business cheap even better um if you read through Buffett's letters it's very clear what he's looking for uh first thing he's looking for anyway is uh businesses that ear in high returns we call it un tangible capital and that just means every business needs working capital every business needs fixed

assets how well does it convert its working capital fixed assets into earnings so the example I used in the little book which I really wrote to explain these kind of Concepts to my kids I said imagine you're building a store and you have to buy the land build the store set up the display stock it with inventory and all that cost your $400,000 and every year the store spends out 200,000 in profit that's a 50% return on tangible Capital maybe I should open more stores not so many places I can reinvest my money at those rates uh then I compared it to another store remember I wrote this for my kids and I called that store just broccoli it's a store that just sells broccoli and it's not a very good idea uh unfortunately stuff to buy the land build the store set up the display stock it with inventory that's still going to cost you roughly $400,000 uh but because it's kind of a stupid idea just to sell broccoli in your store maybe it only earns $10,000 a year that's a two and a half% return on tangible capital and all I'd simply say is I'd much prefer to own the business that could reinvest its money all things being equal much prefer to own the business it can reinvest its money at high rates of return than much lower rates of return um and so that's sort of

the buffet twist that uh we incorporate uh in the companies that we invest in by being very tough on the way companies uh earn and spend their money uh so we tend to get a a a group of companies that are not only cheap but also uh deploy Capital we and and that's really what we're uh looking for so we've always done that uh the little book with more of a way to systematize that but and you can be a stock market genius which uh you know what did we do in the first 10 years I wrote a book about it it was uh you can be a stock market gen was looking for off the beaten path more complicated uh things that other people weren't looking at something strange or different was going on I showed people nooks and crannies in the market where they could look for those the issue there uh and there is no issue it's a it's a it's a great business but our portfolios were six or eight names were 80% of our portfolio uh we returned half our Capital uh outside Capital after 5 years returned all our outside Capital after 10 years between uh 85 and 94 we were lucky enough to uh have enough money to keep our staff and continue to run our money uh thereafter uh you know Warren Buffett said the um uh a fat wallet's the enemy of uh High investment returns uh and so when you have a very concentrated portfolio

and you're looking off the beaten path where there are kind of smaller situations and things that are more obscure you're very liquidity constrained that's why we kept uh returning money uh but that's not why we're doing what we're doing now uh if you're going to run other people's money uh this is what I'll tell you with a portfolio that has six or eight names that are 80% of your portfolio every two to three years usually within two uh Rob and I uh my partner Rob goldsteen and I would wake up and uh we'd find out we just lost 20 or 30% of our net worth uh and happened like clockwork every two three years just always happened it has to happen with a concentrated portfolio either because we were wrong on one or two of our picks or uh you know Market they were out of favor for some period of time and maybe it bothered us maybe it didn't if we just had to be patient uh but I would say for outside uh you know when I was talking about people going in and out of funds and and losing the return that is not conducive for other people especially if they're not doing the work it was okay for us uh and I think it was it was it was good for us because we knew what we owned and so as

long as the facts hadn't changed and as long as we uh believed in our thesis we we could take that I wouldn't say it was easy but we could take that now our bad days we have hundreds of stocks on the long side and hundreds of stocks on the short side we're trying to be right on average we're buying cheap good companies we're shorting uh companies that are either destroying capital or losing money or whatever it is and over time that pays off and but are bad days with hundreds of stocks on a are 20 or 30 basis points of underperformance not 20 30% of our net worth uh and so I think for most people it's a smoother ride and um one of the great lessons that uh young investors a lot of you guys are still very young uh can learn are the compound interest tables you know if you can make mid teen returns we wouldn't make 40 or 50% annualized returns but in mid- teens returns uh if you know compound interest tables you could do very well over uh you know with a smoother ride over long period of time uh one of the uh uh the best examples when I when I taught those ninth graders I actually put on the outside of their notebooks I handed them notebooks and on the outside I had a compound interest table and it had the example of uh

starting investing uh $2,000 a year when you're 19 uh you know in your IRA until you're 26 uh so seven years of putting away 2000 and never putting another nickel in again or starting when you're 26 and putting in 2,000 a year for 40 years until you're 65 so uh the people who put in 2,000 a year from age 19 to 26 and never put in another nickel ended up with more money if you earned 10% a year on that money uh they ended up with more money with those seven payments than the people who started 26 and put in 40 payments till they were 65 you end up with more money uh the the 19th to 26 just a very important lesson to learn about starting early I know all of you are over 19 so I'm sorry I didn't tell you this but but these kids these kids weren't and so uh compound interest uh tables are important so uh you're young uh if you if you stay with a very methodical investment strategy that makes sense over time uh you can all still do very very well so Joel thanks you've talked about the size effect right you know going into hidden places and obscure areas as well uh you also talked about the temperamental Edge that you can bring to the process of investing uh and then there's something you know something to say about the analytical

and the informational Edge and there used to be a lot of you know investing in you know net Nets uh payback and do you think some of these edges have become less relevant versus more relevant over time uh with information becoming almost universally accessible now well uh information I mean people have information on the S&P 500 stocks uh there's still a lot of group think going on uh some of these situ you know what I tell my students is some of these smaller cap you know what happens if you're very good at doing things like you read you can be a stock market genius and and buy some of these things in these obscure places and what I would call it is taking unfair bets you know not because uh you're so smart but because you found it in a place that other people aren't looking uh what happens to people who get good at that is they a lot of money and then they can't do that anymore uh because they have too much money uh so it opens a whole new uh area for young people to keep coming into to that so certainly some of the smaller situations will always be there uh the things may be a little more efficient but there have been plenty of studies you know one of the big chapters I wrote was on spin-offs which are companies that are sort of separated from and those still work very well but

it sort of Misses uh you know they've studied like if you bought all the spin-offs how would you do and they they continue to outperform that's not really the question the question is is this an area ripe for mispriced Securities I mean if the average spin-off did average that wouldn't mean anything to me you're looking for the opportunity where people are discarding things or just not interested in things for reasons that don't have to do with the investment merits they may be too small it may not be the company that the people who owned the original stock invested in uh usually uh you discard companies that uh are out of favor at that time so even though on average they've continued to outperform pretty much as well as when I wrote the book so that's not discouraging but even if they did average it they still are ripe for mispricing really what I'm looking for so you're looking in these areas that are ripe for mispricing it's you don't have to run a statistical model to decide whether on average they do well or they don't if you know what you're looking for you're looking for opportunities to find things that are misprice and I don't think those uh will go away um but as I said you know there are higher higher and better uses for most people's

time um so I had a ball doing that I have a ball doing what I'm doing if you don't want to do it fine with me in one of your recent interviews you know you I think you mentioned Apple you know one of the big companies and you think group think and mispricings can happen even in big companies so maybe you know apple or some other company I was wondering if you could like take our audience through an example of what are the metrics one should be looking at if they were looking at a company well I'll pick apple is just big big picture you guys have heard of that yeah so uh you know you know at least I'm old enough to have had a Blackberry and and uh you know used to have 50% of the market now it doesn't really exist it wasn't that long ago uh and some people uh and the vast majority of uh Apple's profits come from their phone uh so that's the negative netive story on Apple it's a hardware company it's going to crash and burn like all of them do okay uh on the other hand uh some people might say oh it has an ecosystem of products that play off one another uh they interact with one another it has a brand you know I always say hey Coca-Cola doesn't make sugar water and they you know have kept their brand pretty well people tend to like apple

has a brand and uh and so the question is which is it you know is it a hardware Apple a hard W company or is it a ecosystem of products with a great brand name I'd say the answer is probably gray somewhere in between it's not either one it's probably somewhere in between those two uh but you know the if you if you took a look at the market uh you know I can look at where the S&P is trading I can look where Apple's trading uh and uh you know you know a few months ago it's still very cheap but a few months ago was trading at less than half of the valuation of the S&P so at a price my answer is if it's somewhere in between I'd say it's probably better than average and I'm getting it at half price I don't know if that's right I have a large margin of safety I own hundreds of bet you know what I say is what we do now is I don't know the answer to your question it's gray I don't know the answer I don't know if it's closer to hardware company I don't know if it's a if it's a ecosystem with a brand attached and you know so so it's it's much much better but you know with uh interest rates are 2% it's got a 10% free cash flow yield earns High Returns on Capital it's got a great Niche what I would say is uh I don't know if Apple's going to work but

I don't own just Apple I own a bucket of apples I own a bucket of companies with metrics like that trading really cheap uh with uh deploys Capital well with uh nice potential Pro uh prospects uh and so I don't know if Apple's going to work I know bucket of apples is going to work that was the chart I showed you and so we own the bucket of apples uh but if you ask my bet on Apple I think it's cheap relative to um to other choices right now fantastic I just have a couple of questions Joel quickly uh you mentioned Index Fund in the beginning of your talk with all the money flowing into passive funds ETFs and index funds what would be your contrarian moves during a period like that what should in are there things investors should be cous about for example um well I I told you where I thought the market in general you know it's a market cap weighted index the S&P uh 500 uh was expensive but still expecting positive returns going forward it's a world of Alternatives so the question is uh you know how should I invest my money um you know the move to passive uh can C you know with all the ETFs and everything else can cause dislocations uh in the short term because uh people are not Discerning uh each company remember I said uh stocks

are not piece of paper that bounce around that you put sharp ratios and stinos on their ownership shares of businesses and businesses uh there's a dispersion in their uh fundamentals uh you know how one's doing versus another when you just uh take an ETF and don't discern between the differences in the fundamentals uh that can cause dislocations in the short term uh that just makes me smile more uh because those dislocations mean hey I can find Bargains because people stop thinking uh but I don't think they're at such an extent that other than in the short term I think you're familiar when the market Falls and everyone gets depressed all at once uh they say correlations go to one that just means everyone throws the baby out with the bath or they to make no discernment but that really just happens for the first month maybe two at the most and then there starts to be discernment that's actually the best opportunity time for us um when people start Discerning again and you just had everything move together which it shouldn't they all have different prospects um and so the same with ETFs if there's flows into them or you know the indexes uh that could cause short-term dislocations over a month or two but those get corrected over time uh like I said the market eventually gets

it right uh you know uh there's a lot of uh if you just think of the jelly beans you really get it it's it's uh the Jelly Bean effect of when everyone hears what everyone else is thinking that happens most of the time that's what the stock market is your job is to be cold and calculating uh and unemotional unfortunately people are human uh it's good news for us uh but uh people I mean the the stats are against you uh that's why uh I think the indexers uh get it right for the wrong reasons they mostly are saying the Market's efficient uh and have other explanations of why you can't beat it I think the market often gives you opportunities but it's very difficult to take advantage of them for Behavioral en Agency problems uh and those are much more powerful than you would think by just saying oh behavioral en Agency problems uh the People Are People and uh it's been happening forever I don't think it's getting better I think time Horizons are shortening uh there's so much all that data all you know look when I started my first firm in 1985 I used to write quarterly letters and they read something like this uh we were up 3% last quarter thanks a lot that's what it sort of said uh now you know we have 10 and2 billion do endowments that uh need

to get our uh results weekly I don't know what they do with them uh but we now have to do that uh and you know these are they most of them do do a good job with it but uh that's just the way of the world so if you keep measuring things in shorter periods and you can measure them and there's more data it doesn't make it better uh it makes you more susceptible to emotional uh influence uh so that world's getting better The Last Man Standing is patience uh uh you know we call it time Arbitrage other people call it time Arbitrage just being patient that's in really short supply uh it's not getting better it's it's uh things are moving to faster and less patience um so that's really the secret uh so now you don't have to even read the big secret I I think one fantastic gift you've given to the value investing Community is the value investors club I'm sure most people here have already visited the website if you have not please check it out uh it's an amazing resource Jo if you could maybe just just say a word about the value investing uh investors Club what what's your vision with it going forward and how does it compare or contrast it with other investing platforms that are emerging these days sure well originally started in 1999 and uh you know the whole big thing with the

internet back then was getting millions of eyeballs to to look and and I viewed it more as a wow you know I always wanted to be an investment club and you know I thought hey I could form an investment Club where you can meet any time at your convenience wherever you are were and share ideas uh and back and forth about it and I'm always grading papers at Columbia for my students and uh you know at the time there were Yahoo message boards where 99.9% of the stuff was not worth reading so uh there's um I sort of said hey why don't we uh along with my partner John Petri I said why don't we vet the people who can join the value investors club and if you would have gotten you know maybe two or three people in the class each year would get an A+ and if you could write up an investment thesis that I would have given an A+ to in my class you can join the club and it's free um uh the only thing uh that you have to do is uh share your best ideas you have to share a couple of your best ideas during the course of the Year and that entitles you to see everybody else's uh good ideas and so it's just Merit based uh and you know still only one out of 20 applicants get in uh so I think it's a little harder than Harvard I don't know um uh

but uh you know it's been going now for 16 years we we do have a uh I think it's a 45 or 90 days delay that if you're not a member but to get the live stuff you have to be a member so learn how to uh value a business and uh apply uh if you like there are instructions on the website it's called the value investors Club but as a learning tool I always refer people there because these are very smart investors they beat each other up you know there's a Q&A after they post something and say what about this what about that a great rating out of 10 is like five because everyone's mean and and uh you know very they're value investors they're very tough and stingy and so they don't you know so if you if you if you look at the ratings and see anything a five or above uh that's good these guys and uh you can look at that it's just a learning exercise right it's it's teacher man to fish that's really how to to uh be good at investing it's not anything else you got to understand what you're doing it's a great way to learn so I think you know for the Next Generation uh it's a nice way to teach them to look at what smart investors are doing now doesn't mean I agree with everything on the site uh uh and and that's this is a good point I'm probably wrong more than I'm

right about passing on things uh but you know Warren Buffett calls uh it you know no called strikes on Wall Street uh you know you could let a 100 pitches go by and you should have swung at 30 of them but if you only pick one and you make sure that's a good one uh that's really the way that we go about investing I just have to uh my partner Rob Goldstein and I are very tough on each other so we both have to like it uh we both have to argue our points and and uh if we both like it you I you know we think it's pretty good so we're really really pick you know picking our pitches doesn't mean we don't miss a lot of good ones it doesn't matter if we miss them it just matters the one we pick are good and uh that's sort of the way to think about uh you can be a stock market genius type of uh investing uh what we're doing next now in our long short portfolios is more being right on average I showed you that chart where we're pretty good at valuing businesses so we buy a group of businesses where we have a bucket of apples you know and uh we're short of bucket of high price companies we're going to be short uh some things that lose money but uh you know are the Teslas and Amazon of the world or you know selling at 100 times free cash flow uh and people get

confused because I I call that the tyranny of the anecdote in other words we will short some wrong ones we won't short much of them but we'll we'll short some and we'll be wrong and you'll know their names because those were the winners but if you're short hundreds uh take my word it's not a good idea to eat through cash or lose money or sell it a 100 times free cash flow uh and usually if you're generating lots of cash and you can buy that cheap and they're deploying their Capital well that's a good thing to do and so we're just trying to be right on average two different ways to do it doesn't make one better than the other uh uh their their different ways to uh to make money uh I love them both would do both again uh they're just both full-time jobs great and Joel our final question goes maybe you know one step ahead into valuation in your books uh you've spoken about different kinds of multiples that are used to Value companies you've spoken about Enterprise Value to free cash for example ev2 abeda is one of those multiples and lots of such multiples you say have been proven effective for long-term investing as you're buying a bucket or a basket however the question is due to the lack of a single source of accurate Benchmark

markets because they're oneoff charges and things you have to clean up for there are many sites on the web claiming a wide range of numbers some good not some not so much have you thought of having a standardized maybe open-source implementation to Benchmark these metrics over the long term you know In The Same Spirit of magic formula Investing For examp okay uh I think I'm a nice guy but not that nice so uh we we have a team of analysts we go through every balance sheet income statement cash flow statement in the companies we look at what's that deferred tax asset or pension liability or off balance sheet plant in Taiwan how should we handle that uh you know how efficient are they at using and spending money we do all that work uh when I wrote the little book I called that the not trying very hard method it worked incredibly well uh using rough metrics uh you know type you're talking about rough metrics uh and it worked incredibly well uh my partner Rob and I looked at each other and said you know this not only worked well it worked much better with those you know not trying very hard than we even thought can we improve on that you know uh can we we actually know how to Value businesses can we just go do that and we put together a research team and we do that um it would be really nice if I shared

that with everyone but it's a lot of work and uh the other way works incredibly you're a nice guy I am a nice guy and so we're trying to treat our clients really well on that happy note thank you so much Jo it's been a pleasure thank you very much thank [Applause] you for