Joel Greenblatt (Trades, Portfolio) is a legendary value investor and the founder of Gotham Asset Management, where he has achieved an annual return of approximately 40% over the past two decades according to my estimates.
At a Hedge Fund Association event in April, Greenblatt sat down for a fireside-style chat with Paul Gray, an up-and-coming hedge fund star and founder of Ironhold Capital Management. In part two of this series, I have summarized this conversation, which covers Greenblatt’s thoughts on position sizing and how he is navigating the markets in 2023. Let’s dive in.
How to size positions
Greenblatt was asked about his secret sauce when it comes to the huge returns he achieved in his early years. One of the key factors of his success was his “focused portfolio” and how he sized positions effectively at the time. The guru explained that it is best to take big positions in investments you think you “can’t lose money in” or have minimal chance of doing so. This is the essence of an “asymmetric” opportunity, which has low risk but potentially high reward. In Warren Buffett (Trades, Portfolio)’s phrasing, this can be thought of as stepping over one-foot hurdles and not trying to swing for the fences with every investment.
Greenblatt explained that throughout his career, he has not taken large positions in investments that seem to offer “10 times or 20 times” your original money, as these often come with greater risk and uncertainty.
Handling volatility
Greenblatt responded to a question from Gray on how he and Gotham Capital maintain their positions in the face of volatility. He said, “Unless you bought a stock at the all-time low,” the “stock will go down after you bought it."
If you have this expectation and awareness upfront, you will not be shocked when it happens. This will give you more emotional stability and the mental strength to be able to hold an investment even when the market goes against you.
While managing smaller sums of money or having more concentrated positions, this can of course increase volatility. Greenblatt recalled early in his career, his net worth would drop by 30% in a day, which would be stomach-churning for most people.
A benefit of the volatility is it “gives you the opportunity” to buy a stock cheaper than its value.
How to analyze management
Greenblatt explained how important management of a company is when looking at potential investments and what attributes, in particular, he looks for.
He used to meet with management using the scuttlebutt technique. But he said he was not able to discern which were good or bad just on first impressions as most of these individuals seemed highly skilled and knowledgeable. However, over time, he figured out that it mattered more to “look at what they have done in the past rather than what they have said."
If they have been smart “capital allocators”and gotten great returns on capital in the past, then the best assumption is to assume they will “keep doing that." This also works the other way around if they got poor returns on capital in the past.
Mathematically, Greenblatt has also proved this is true on average using statistics.
Another factor he analyzes is how management gets paid. He looks at bonuses tied to how much a stock goes up, relative to their base salary. Really, Greenblatt is looking for skin in the game and alignment with shareholders as business owners. Insider selling or buying can also help to track this.
Gray added that “management has a track record” just like people do, so it is important to look at it from that respect.
Investing in technology
Greenblatt then spoke on the recent drawback in investing within the tech sector and whether it is similar to the dot-com bubble of the late 1990s and early 2000s and if it made sense for value investors to jump in at that particular moment.
Greenblatt explained what his firm was doing during the bubble and the percentage loss and gain Gotham Capital faced during that time.
In 1998, the market was up 28% and Gotham Capital lost money for the first year ever, down 5%.
In 1999, the market was up 21% and Gotham lost 5% again.
However, in 2000, the market was down 10% and Gotham was up 115%.
Greenblatt humbly admitted that he did not believe he was a “genius in the year 2000” or an idiot in 1998 and 1999 when he lost money.
Instead, the firm “finally got rewarded” for all the work it did in the years leading up to it. A key lesson from this is, investing is a long-term game and if you have made the right investments upfront, the market will reward you eventually.
Is now a good time to invest?
As for the current situation in the tech markets, Greenblatt explained the same “dichotomy” does not exist in the markets today. He referenced a calculator the company uses which shows stocks were in the 94th percentile toward cheap, relative to the last 30 years, as of April 2023. This would mean being a net buyer would make the most sense, as stocks have only been cheaper 7% of the time in the past 30 years.
Interestingly enough, I checked the same calculator in June, which showed stocks have moved to the 84th percentile toward cheap. Therefore, this generally means stock prices have increased as one would expect. The average forward-year return is now close to 54%.
This is fantastic, though investors need to remember history does not always repeat, it just tends to rhyme. Further, this portfolio is for the top 700 to 800 U.S. stocks chosen by Gotham. The S&P 500 was actually in the 23rd percentile toward expensive. However, positive returns were expected and close to 14% and 15% were returned.
Artificial intelligence
Greenblatt expressed his excitement and anticipation for artificial intelligence in that he is looking forward to what it has the potential to do, but noted he is not completely aware of what it really is yet.
The investor mentioned that even with the rise of technology within the last 20 to 25 years, the market has seen trends. He took a specific example of the S&P 500 and how from 1997 to 2000 this index doubled, while from 2000 to 2002 it halved, then from 2002 to 2007 it doubled again and then from 2007-2009 it halved again. Since 2009, it has tripled and now there is a fall of around 20%.
Computers and AI really help more with short-term trading. However, individual investors have a key advantage, which is patience or, as Greenblatt likes to call it, “time arbitrage."
Building a successful life and business
Greenblatt shared what attributes of business he applied to Gotham Capital in order to help make it successful in terms of finding the best talent and building its assets under management.
He said it is about finding people who genuinely have a “passion” and “love the challenge” as opposed to just making money. Greenblatt has noticed these people tend to be more successful over time. This “genuine passion” also helps one to be successful in whatever line of work they choose.
Then, after an individual has become successful and made money, they can “give back,” as Greenblatt has done with his philanthropic and charitable initiatives, specifically the Success Academy.
Greenblatt talked about how he believes education is one of the most unequal things that is done in this country, as the place you go to school is decided on where you live and many have no other choice.
His initiative is a charter school that is meant for people who do not have the best public school access. He believes that education is a great tool for people to have and that all kids should have equal and fair access to it no matter their financial status.
Final thoughts
Greenblatt is an incredible investor, so I am extremely grateful he still takes the time to share his vast wisdom. His strategies on position sizing and how one should expect a stock to fall in price in the short term are also immensely valuable in order to be successful.
The guru also dropped a few hints about a new book coming out soon, so we can expect more wisdom to follow.
