Super Investor #14 in our series is Joel Greenblatt – The Magic Formula Investor.
Who is Joel Greenblatt?
Joel Greenblatt has earned his place among the greatest investors of all time, not only for his stellar track record at Gotham Capital but also for revolutionizing how individual investors approach value investing. By distilling complex investment principles into simple, actionable strategies, Greenblatt created a framework that empowers everyday investors to beat the market without needing a Wall Street-level education.
Best known for his “Magic Formula,” Greenblatt’s philosophy combines the rigor of fundamental analysis with the practicality of systematic investing. His work, particularly through his bestselling book The Little Book That Beats the Market, has made him a household name among value investors.
Joel Greenblatt: Early Life and Background
Born in Great Neck, New York, in 1957, Joel Greenblatt displayed an early aptitude for analytical thinking. After earning a degree from the University of Pennsylvania’s Wharton School, he went on to obtain an MBA from the same institution in 1980.
Greenblatt’s professional journey began at a time when value investing, championed by legends like Benjamin Graham and Warren Buffett, was gaining mainstream traction. Inspired by their philosophies, Greenblatt sought to refine the discipline, focusing on creating a replicable, data-driven approach to investing.
In 1985, Greenblatt co-founded Gotham Capital, a hedge fund that quickly distinguished itself through exceptional returns. From 1985 to 1995, Gotham Capital delivered a staggering annualized return of over 40%, solidifying Greenblatt’s reputation as a master investor.
Investment Philosophy: How Joel Greenblatt Approaches the Market
Joel Greenblatt’s investment philosophy is deeply rooted in simplicity and discipline. He emphasizes buying high-quality companies at a discount to their intrinsic value—an approach he calls “Magic Formula Investing.”
Core Principles
- Focus on High-Quality Businesses
Greenblatt defines “quality” through a company’s return on invested capital (ROIC), a measure of how efficiently a company generates profits relative to its investment base. Businesses with high ROIC tend to have competitive advantages, or moats, that allow them to sustain profitability. - Buy Undervalued Stocks
The Magic Formula pairs high ROIC with a high earnings yield, which compares a company’s earnings to its market price. This ensures that investors buy great businesses at attractive prices. - Long-Term Discipline
Greenblatt urges investors to think long-term and avoid emotional reactions to short-term market volatility. His strategy works best over a horizon of 3–5 years, during which the market tends to recognize and correct undervaluation.
The Magic Formula: Breaking It Down
Greenblatt’s Magic Formula relies on ranking stocks based on two metrics:
- Return on Invested Capital (ROIC): Measures the efficiency of a business in generating returns from its investments.
- Earnings Yield: The inverse of the price-to-earnings (P/E) ratio, this indicates how much a company earns for each dollar invested in its stock.
Using these metrics, the formula ranks companies in order of attractiveness. Investors then select stocks from the top-ranked list, diversifying across 20–30 businesses.
Example of the Magic Formula in Action
Imagine a software company like Microsoft (MSFT) with:
- An ROIC of 40% (indicating high efficiency).
- An earnings yield of 7% (implying a reasonable valuation).
The Magic Formula would rank Microsoft highly, signaling it as a potential investment. By targeting companies like this, Greenblatt’s strategy ensures investors focus on profitable, undervalued businesses.
Notable Investments and Track Record
During his tenure at Gotham Capital, Greenblatt made numerous high-profile investments. While the fund’s specific holdings were often private, its performance spoke volumes. With an annualized return exceeding 40% over a decade, Gotham consistently outperformed benchmarks, even during volatile market conditions.
One notable example of Greenblatt’s expertise was his investment in undervalued spin-offs. He recognized that spin-offs, or newly independent companies separated from their parent firms, were often overlooked by institutional investors despite their potential for outsized returns.
Lessons for the Everyday Investor
Joel Greenblatt’s investing success holds valuable lessons for individual investors:
1. Focus on Quality and Value
Always look for companies with strong fundamentals, such as high ROIC and solid earnings. Avoid speculative investments or businesses you don’t understand.
2. Invest Systematically
Greenblatt’s Magic Formula proves that a systematic, unemotional approach often outperforms intuition. Consider using stock-screening tools or formulas to eliminate bias.
3. Think Long-Term
The market doesn’t immediately reward good decisions. Greenblatt emphasizes patience, as the Magic Formula works best over several years.
4. Diversify Wisely
While Greenblatt avoids over-diversification, he recommends spreading investments across 20–30 stocks to mitigate risk.
5. Keep It Simple
Greenblatt’s ability to simplify investing principles demonstrates that success doesn’t require complexity. His approach is accessible to anyone willing to put in the effort.
Challenges and Criticisms of Joel Greenblatt
Although Greenblatt’s Magic Formula has been widely celebrated, it isn’t without limitations:
- Market Efficiency: In larger, more efficient markets, the formula may struggle to identify opportunities.
- Behavioral Challenges: Sticking to the strategy can be difficult during prolonged periods of underperformance.
Despite these challenges, Greenblatt’s long-term results validate his philosophy, and his work continues to inspire investors worldwide.
The Legacy of Joel Greenblatt
Joel Greenblatt’s influence extends far beyond Gotham Capital. As a professor at Columbia Business School, he has mentored countless students, sharing his insights on value investing. Through his books, particularly The Little Book That Beats the Market, he has democratized investing, making it accessible to millions.
Greenblatt’s emphasis on education and simplicity has inspired a generation of investors, proving that anyone can achieve success by following a disciplined, systematic approach.
Timeless Quotes and Wisdom from Joel Greenblatt
- “The secret to investing is to figure out the value of something – and then pay a lot less.”
- “If you can’t beat the market, be the market. Indexing is a fine strategy for most people.”
These insights encapsulate Greenblatt’s pragmatic and disciplined approach, reminding investors to focus on value and avoid overcomplication.
Conclusion: The Enduring Influence of Joel Greenblatt
Joel Greenblatt’s remarkable career demonstrates that investing doesn’t have to be overly complex to be effective. By focusing on quality businesses and disciplined valuation metrics, he has shown that success is attainable for any investor willing to follow a systematic approach.
For individual investors, the lessons from Greenblatt’s Magic Formula are invaluable: prioritize quality, invest with patience, and avoid emotional decision-making. Whether you’re a seasoned investor or just starting, applying his principles can set you on the path to long-term wealth creation.
Happy Investing