Joel Greenblatt: Investment Principles That Actually Beat the Market
Since this newsletter is titled The Little Substack that Beats the Market, it is only fitting that we kick off our new section on investment principles with the man himself: Joel Greenblatt.
Since this newsletter is titled The Little Substack that Beats the Market, it is only fitting that we kick off our new section on investment principles with the man himself: Joel Greenblatt.
For those unfamiliar with him, Greenblatt is the founder of Gotham Capital, where he achieved an astonishing 40% annual return over two decades. In this note, we distill his core investment principles, gathered from his books, letters, and lectures, into a practical framework.
Here are the key takeaways:
I. PHILOSOPHY & MINDSET
What is value investing? It is simply figuring out what a business is worth and paying a lot less for it.
Reversion to the Mean: Markets love to extrapolate the past. They assume good companies will stay good forever and bad ones will remain bad. They won’t.
Mr. Market is Your Friend: Volatility is not risk—it’s opportunity. Market pessimism is often the best time to buy.
Margin of Safety: The goal is to minimize losses if we are wrong.
The “Too Hard” Pile: If a business is difficult to understand or value, skip it. We have the luxury of waiting. As Greenblatt puts it: “If I don’t find anything great, I wait.”
II. WHERE TO LOOK
Focus on Small Caps: Fewer analysts cover these stocks, so there are more inefficiencies and a higher chance of finding mispriced assets.
Special Situations: Events such as spin-offs can lead to attractive entry points by creating forced selling unrelated to fundamentals..
III. WHAT TO LOOK FOR
The Magic Formula: The combination of two factors: High Quality (High ROIC) and Low Price (High Earnings Yield).
ROIC (Return on Invested Capital): Look for consistent returns of 10-12% or higher. Note: Calculate this excluding goodwill to see the true efficiency of the operating engine.
Asset-Light Models: We prefer businesses that can grow without requiring heavy capital reinvestment.
IV. VALUATION
Triangulate Value: Never rely on one number. Cross-check using DCF, Comparables, Liquidation Value, and Private Market Value.
Normalize Earnings: Do not use record years or trough years as your baseline. Smooth out the margins to find the normalized Free Cash Flow.
V. PORTFOLIO MANAGEMENT
Concentration: Diversification is a hedge against ignorance. If you know what you are doing, 5 to 8 high-conviction ideas are sufficient to manage risk and maximize upside.