Joel Greenblat and Value Investing

I wrote a short posting before about Joel Greenblatt, this time I like to present more material.

The first time I heard about Joel Greenblatt is when a friend recommended this book a long time ago to me:

"You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits"

It is a great book about "special situations" (mergers, spinoffs, arbitrages, etc.), definitely not meant for a beginner in stock market investing. The only minor point for people interested in Asian investing is that it is 100% focused on the US market (as unfortunately the large majority of books about investing). It is written in 1985, but still relevant and I would highly recommend it, the logic presented is very compelling.

Twenty years later he followed with:

"The Little Book That Beats the Market"

It provides a rather simple formula to chose and pick shares. The returns, backtested on a reasonable large sample, looked very promising. Basically the formula choses shares with a high ROE at a relative low PE multiple.

[As "K C" rightly pointed out in the comments, Greenblatt actually uses EBIT (Earnings Before Interest and Tax) and EV (Enterprise Value), I use myself ROE and PE, I think the two methods are quite similar]

Since no formula is perfect, users of the formula are encouraged to pick about 20 to 30 different companies, to diversify the risk.

Five years later he followed this up with"

"The Little Book That Still Beats the Market"

An updated version based on the latest data.

I have to admit, I haven't read this latest book, I found the proof in his previous book compelling enough.

Also, the proof that his formula is still working can be found here, a presentation Greenblatt held at the 2009 Value Investing Congress:





The link to the presentation slides can be found here.

Quite amazing that such a simple formula is enough to beat the market, while more than half of the US fund managers are trailing the relevant index.

The Magic Formula's website can be found here.

The holdings of the "Formula Investing US Value Select A (FNSAX)" which uses the formula for its stock selection can be found here.

Big question for Asian investors: would this formula also work, say in Malaysia or Singapore? My guess is it would indeed work. But unfortunately the data to test this assumption is not readily available, like in the US.

Magic Formula that beats the Market

Joel Greenblatt wrote The Little Book That Beats The Market

"Greenbackd" (a fundmanager) analysed the results, also based on research from others. It looks like the formula is true in most countries, although less so than in the US.

The strategy itself is rather simple, "long term deep value": "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".

Regarding the timeframe: "In the second chart, note that it took eight years for the value decile to catch up to the glamour decile. They were tough times for value investors". In other words, one needs a lot of patience.

In countries with good corporate governance I expect the formula to do better than in countries with lousy corporate governance.