Project Description

Masters in Business: Joel Greenblatt on Relative Value Investing

  • October 13, 2020
  • Interview
  • Transcript
  • What motivated you to write a book about opportunity and equality?
    • Joel is a capitalist and would like the system to work.
    • Lot’s of problems that capitalism has led to.
    • Reasonable to suggest a few tweaks to make it work better for everyone.
    • Wrote the book from the perspective of a long term investor.
  • Joel started a charter school. Why?
    • If you look at statistics. If you are black, Hispanic, low income in a major city, your odds of graduating college are 1/11.
    • College graduates earn 70% more than high school graduates.
    • High school graduates earn 30% more than drop outs.
    • That’s huge.
    • If you have money, and you don’t like the school in your neighborhood, you can switch schools or go to a private school. If you don’t have money, you can’t.
    • That’s why Joel supports charter schools.
    • Charter Schools: publicly funded schools not run by the district, run by independent operators.
    • Turns out that charter school in states where they have high standards of who gets to open one (like Mass, New York, and California) tend to do well.
    • Idea was to open a charter school in New York City and invest resources to make it not only successful, but repeatable. Big, hairy, audacious goal was to open 40 schools.
    • Joel and biz partner hired Eva Moskowitz as the CEO. Success Network.
      • Today have 46 schools and 20,000 kids.
      • Last year, those 20,000 kids from low income areas outperformed kids from every wealthy area in the state (Scarsdale, Great Neck, etc.) according to state tests in Math and English
  • What lesson can we learn from to bring to public schools?
    • It’s not lack of ability. The kids can do it.
    • If you have high expectations, the kids can meet your expectations if they have the right support.
    • Some advantages to charter schools. Kids get to select their teachers and keep the ones that they think are doing a good job.
    • Charter schools can pivot quickly to only do what works. In public schools, it’s more bureaucratic
    • Spend 30% more time in school at Charter school than at public school.
    • Parents choose to come. Good to have support of the parents.
  • You highlight public school PS172 – one of countries best public schools. Why is that school performing so well?
    • Book is not just about charter schools. Parents of students from low income areas don’t have a choice of where they go to school so the book talks about how we can give those parents choices and improve their district schools.
    • One book that Greenblatt highlights in his book is PS172. Principal of school is Jack Spatola (just retired).
    • How good some schools can be: 99% of kids with disabilities passed math exam. 94% passed the English exam. Most other schools it’s below 40% for kids without disabilities.
    • Having high expectations for every child. If something doesn’t work, try something else. If that doesn’t work, try something else, but keep expectations high regardless of disabilities, etc.
    • Only principal can be the best in the state, it’s probably Jack.
  • Joel writes about in the book how to get the 10/11 low income area kids to go to college. Because it’s not due to a lack of ability.
  • One option is alternative credentials. What does that mean?
    • Joel calls it alternative certification. He points out that the current system isn’t working for 10/11 students from low income areas.
    • Joel poses question to his students at Colombia. How do you beat Tiger Woods when he was at the top of his game? Answer: Don’t play him in golf.
    • Idea that Joel suggests is Alternative Certification. Example. Let’s assume you want to work in HR department at Microsoft. Microsoft should come out with certificates, English literacy requirements, game based test, etc. that they would consider in lieu of a college degree.
    • Google, Amazon, Microsoft, JPMorgan. These leading companies wouldn’t have to create these courses or certificates. They would just have to disclose what courses, tests, certificates should be considered in lieu of college diplomas.
  • What is response from the leading companies?
    • The book just came out.
    • Joel is trying to get the idea out there.
    • Time will tell.
    • Google is doing something similar. But idea is to make the requirements public so that people without college degrees could still access good opportunities.
    • One other benefit: would require no government involvement.
    • Cost could be much lower.
    • What would you do for students that are disadvantaged?
      • Would hope that an entire online ecosystem would develop with tutors and online courses.
  • Greenblatt has previously stated that banks are wired to get into trouble – why is that the case?
    • Pretty straight forward.
    • Money is fungible.
    • Who lends money at the cheapest rate wins. So banks are incentivized to sacrificed lending standards to grow faster.
    • The industry is competitive and very leveraged.
    • Pretty straight forward why they are wired to get into trouble.
  • How do we improve banks so they aren’t too big to fail?
    • After GFC, lot’s of regulation came including Dodd Frank. That helped.
    • But more regulations have very high costs. Only big banks can handle cost. Hurting small banks. Small banks can’t handle the costs.
    • Banks are penalized for making small business loans. Small business loans under $1MM have dropped by 75% from 2008.
    • New business formation is down.
    • Haven’t solved too big to fail. Minnesota Fed said 2/3 chance we need another gov bailout in the next century.
    • So hurting small banks and small businesses and haven’t solved too big to fail.
    • Tell story in book, English used to ship their prisoners to Australia. 40% of prisoners died along the way. Terrible. How do you improve this outcome? One option is to reduce death rate with more regulation (better food quality, better monitoring, etc.). They other thing you could do would be to solve the incentives from the beginning. Pay the ship captain for getting prisoners to Australia safely. Don’t pay anything for any passenger who dies. Setting correct incentives up from the beginning works.
      • Same thing with banks. When a restaurant fails, economy doesn’t miss a beat. Not so with banks. They are too big and too intertwined with the economy.
      • Joel suggests that regulation should change so that banks need to have 20% to 30% equity instead of 9% now. To get from the 9% to 20% or 30%, Joel suggests there should be a new preferred equity security. To entice preferred equity investors, the interest paid out should be tax free. This looks like it would be giving a deal to investors, but in reality, it would be solving a problem for the government because the banks wouldn’t be too big to fail. And if the preferred equity holders got wiped out, it wouldn’t be the end of the world.
    • Would this be voluntary for the banks or obligated?
      • If they want to be free of certain regulations, they can issue this preferred and take the risk themselves. Otherwise, they can just be subject to the same regulations that are currently out there in the market.
  • What do you think of Robinhood investors?
    • Think exposing people to the market is a good thing, but speculating without knowing what you are doing is not a good thing.
    • A lot of people lost a lot of money during the internet bubble trading with eTrade. Similar situation here.
    • The best performing mutual fund for the decade ending 2010 generated an average return of 18% per year during a decade when the market was flat. Yet the average investor in that fund managed to lose 11% by moving in and out at the wrong time. Uninformed investors tend to make the wrong decisions.
  • Teach 9th graders in Harlem and teaching Columbia MBA students?
    • Try to teach the 9th graders about the power of compound interest.
  • Thoughts on baby bonds? Give everyone that’s born a $5,000 investment that they can’t touch until they are 25 or older.
    • Like concept but it won’t be enough.
    • Most people don’t have enough retirement savings.
    • Don’t have a system that takes care of that.
    •  One thing that Joel suggests is that your contribution to social security isn’t capped once you reach a salary of $137k. As you make more money, you keep contributing to social security. You get to keep 80% of that and it gets to go into a tax advantaged account, but the remaining 20% goes to low income earners or people just starting out in the work force so they get to benefit from social security.
  • What advantages does the country get from a broader immigration programs?
    • According to business round table, the U.S. comes in second to last among developed countries in terms of welcoming skilled immigrants.
    • The only country we beat is Japan which literally discourages immigration and you have to speak Japanese.
    • Skilled immigration are actually a natural resource.
      • We make $0.5MM to $1.0MM on each highly skilled immigrant. The math in today’s dollars: how much they and their kids contribute vs. how much they take from the government.
      • For every skilled immigrant that comes, they create two jobs that weren’t already here.
      • It’s a gold mine that we aren’t using.
      • Immigrants have founded 51% of U.S. start ups that are valued at over $1BN.
        • Twice as likely to start a business as natives are.
        • Responsible for 25% of the productivity growth over the past 20 years.
      • H1B program is broken. It’s expensive and uncertain whether someone can stay.
        • 3x the max number of skilled immigrants apply within the first 5 days of eligibility every year. Canada and Australia will take anyone that meets the gov standards of skill, education and ability. The U.S. actively discourages skilled immigration.
      • Greenblatt recommends that companies should be able to sponsor as many skilled immigrants as they are willing to as long as they pay a 20% tax to the government. It would be cheaper to than the current H1B program.
      • Immigrants want to come to the U.S.
  • Value investing has struggled. What’s going on?
    • Gave a speech in the last year: Is Value Investing Dead? Yes, No, Maybe, I don’t care.
    • It depends on how you define “value investing”
    • If you define it as low price-to-book, low price-to-sales, it’s had a tough time.
    • Last 5 years, Growth, the way Morningstar defines it, has outperformed Value by 11% per year
      • Last 3 years, Growth has outperformed Value by 17% per year.
      • Last 12 months, 43% per year.
    • This is greater outperformance than during the years leading up to the internet bubble.
    • If you define value like Gotham does (figure out what a business is worth and pay a lot less), then that is never really out of style.
    • Look at a company like a private equity firm. No private equity company is going to buy a business based on price to sales of price to book. They are buying based on cash flow.
    • Investing depends on cash flows and how those cash flows will grow over time.
    • Growth and value are tied at the hip.
  • If you bought every company that lost money in 2019 that had a market cap >$1BN (261 companies), you would be up 65% this year.
    • In this kind of market, where people are saying this could be the next Google, MicroSoft or Amazon, Greenblatt doesn’t think the froth is in the shares of Google, MicroSoft or Amazon. Those are some of the best businesses that we’ve ever seen in our lifetimes.
    • Greenblatt doesn’t quibble with their valuations. Own a bunch of them. But there are a bunch of companies that “rhyme” with them that are way overvalued.
  • Thoughts on momentum?
    • Momentum has worked for 30, 40 years not just in the US but across the globe.
    • However, trying to figure out the difference between correlation and causation.
    • If momentum stopped working for two years, wouldn’t know why it stopped working. It could be 1) because its cyclically out of favor or 2) because its become crowded and the trade has degraded.
    • Greenblatt looks at stocks as a fractional shares of business and tries to buy them based on a discount to what he thinks they are worth.
    • “If I came to you and said, hey, listen, I have this real estate strategy, I’m just going to buy all the houses that were up the most in the last three months. You kind of look at me like I was nuts. And so although it’s correlated with good returns in the past, that’s not what I would continue doing even though it’s correlated. I’m looking for causation. That’s where I can put it.”
  • Companies that buy back stock tend to do better. Is it correlation or causation?
    • If that is true, its correlation.
    • There is nothing good or bad about buy backs. It depends what price they pay.
    • Causation has to do with smart managements who only buy back stock when its selling at a discount to what they think its worth.
  • Google, Amazon, and Microsoft. Not much competition. Each company dominates its niche. Thoughts?
    • We manage a fund where we own every stock in the S&P 500 and overweight the ones we think are undervalued and underweight the ones we think are undervalued.
    • We are overweight almost all of those big tech players.
    • They are some of the best businesses that we’ve ever seen. We haven’t seen anything like this.
    • These are great businesses.
    • Greenblatt doesn’t have an opinion on whether they should be broken up or not, he’s just investing in them.
    • If you look at the stability of the cash flows and the growth of the cash flows, they are cheap to reasonable, depending on which one.
    • They are not where the froth in the market is.
    • Froth: hundreds of companies that people think will become the next Amazon, Google, and Microsoft. And there just can’t be hundreds of companies that do that.
    • Greenblatt’s funds have beaten the market in a tough period for value investing so it’s not like the principles don’t work.
  • Will traditional value come back?
    • Yes, think it will. Think it’s swung too far.
    • But don’t care if it comes back because it’s not Greenblatt’s definition of value investing.
  • How will we know traditional value is back?
    • If money losing companies have their comeuppance could be a sign that value is back.
  • When evaluating companies, what do you look for?
    • Right now, pre-tax cash flow yield of the S&P 500 is slightly lower than 4%. There are companies with a lower than 4% yield but that have a much higher growth rate than the S&P 500. And then there are companies with higher pre-tax cash flow yield and also have at least as good growth/fundamentals as S&P 500. Both of these types of companies are relative values.
    • There aren’t a lot of companies out there right now that are super cheap. Obviously has something to do with interest rates being so low and stocks being the only game in town.
    • If you told Greenblatt that interest rates will be low forever (which just don’t know) could make some nice money from here.
    • Greenblatt is in the lucky position where people give him money and say I want to invest in the market, how should I do it. Greenblatt prefers to buy companies that are maybe yielding a little less than the S&P 500 but have much higher growth prospects, much more secure franchises. Also, like buying much higher yielding companies with at least as good growth/fundamentals
  • Mentors?
    • Dad. Learned ethics and business man. Shoe manufacturer. Always shared business lessons with Joel. Someone he truly admires.
    • Graham and Buffett. Went to Wharton. They were teaching efficient market. Didn’t make sense. Greenblatt read Graham and then read Buffett and it just made sense. Once of the reasons Greenblatt teaches is because of how much they both gave back.
  • Books that he’s reading now?
    • The Splendid and the Vile. About Churchill’s first year in office. Put Churchill in office right before it looked like England would fall. How he handled that was amazing to read.
    • Love anything about Benjamin Franklin. Read Americanization of Ben Franklin recently. Good one.
    •  Chasing my Cure. A doctor cured himself of an orphan disease that nobody previously had survived. Now he’s attacking covid.
  • Advice to recent college grad in asset mgmt?
    • If you are lucky enough to find something that you are passionate about and get to do for a living, that’s a gift. Buffett called it tap dancing to work. Only people that feel that way about asset mgmt should go into it. To go into it just for the money is not a great choice.
    • If you really love it, you can help a lot of people. And can do good things with the money that you earn, if you are successful.
    • If you love it, all for it, but if not, do something else. There are a lot of other ways that you can contribute to society.
  • What do you know about the world of investing today that you wish you knew?
    • First started investing in net nets. Wrote an article about it.
    • Over time, learned that quality matters. You need to invest in a good business.
    • It’s even more important today to invest in quality businesses. If you want to invest for the long term, you need to own high quality businesses. Learned it  30 years ago and wish he had learned it earlier.