Joel Greenblatt
Founder of Gotham Capital and author
Born 1957
Popularised a simple, rules-based approach to value investing in The Little Book That Beats the Market, and taught investing at Columbia Business School.
Biography
Joel Greenblatt, born in 1957, is an American investor, author and teacher. He studied at the Wharton School, taking both his undergraduate degree and an MBA there, and in 1985 founded Gotham Capital, an investment partnership that concentrated on unusual corners of the market rather than on widely followed large companies.
His early work focused on what are known as special situations: spin-offs, restructurings, merger securities and other events that force a change in who owns a business. His argument was that these situations are structurally under-analysed, because the securities involved are often too small or too awkward for large institutions to bother with, and are frequently sold by holders who received them without wanting them.
In the mid-1990s he returned outside investors' capital and continued managing money privately. He also began teaching a value and special-situation investing course at Columbia Business School as an adjunct professor, a post he has held for many years, and co-founded the Value Investors Club, an online forum where members post detailed investment analyses for critique.
His later books moved in the opposite direction, away from specialist situations and toward the simplest possible method an ordinary investor could follow. The Little Book That Beats the Market, published in 2005, set out a ranking system he called the magic formula, built from just two measures. He has also been involved in supporting charter schools in New York.
Career timeline
- 1957Born in New York.
- 1980Completes an MBA at the Wharton School.
- 1985Founds Gotham Capital, focused on special situations and spin-offs.
- 1996Begins teaching value and special-situation investing at Columbia Business School.
- 1997Publishes his first book, on profiting from spin-offs and other corporate events.
- 1999Co-founds the Value Investors Club, where members post analyses for public critique.
- 2005Publishes The Little Book That Beats the Market, introducing the magic formula.
- 2011Publishes The Big Secret for the Small Investor.
Investment philosophy
Greenblatt reduces value investing to a single sentence: work out what a business is worth, then pay a lot less than that. Everything else in his writing is machinery for making that sentence usable by someone who is not a full-time analyst, which is why his later work moved from complex special situations toward a formula that fits on one page.
The magic formula combines two ideas that value investors usually treat separately. Return on capital measures how good the business is at turning money invested into profit. Earnings yield measures how cheap it is relative to those profits. Ranking companies on both and buying near the top of the combined list is an attempt to own good businesses at low prices, rather than cheap businesses at low prices.
The part he emphasises most is the part that is hardest to sell. A method that works most of the time but not all of the time will underperform for stretches long enough that most people abandon it, and in his view that is precisely why it keeps working for the few who do not. The discomfort is the reason the opportunity survives.
Key ideas
Tap any idea to expand a plain-English explanation, why it matters, and where to learn more.
The magic formula
A ranking that combines return on capital, which measures business quality, with earnings yield, which measures cheapness, then buys from the top of the combined list.
It turns two ideas value investors usually judge by feel into a repeatable ranking that does not depend on forecasting anything.
A company earning high returns on the capital it employs, whose shares are priced at a high earnings yield, ranks well on both halves at once.
Special situations and spin-offs
Corporate events, such as a division being spun off into a separate listed company, that force securities into the hands of owners who did not choose them.
Forced selling is not analysis. When a security is sold because holders do not want it rather than because it is overpriced, the price can detach from the value.
A large index fund receiving shares in a small spun-off business may have to sell them regardless of what the business is worth.
A strategy has to be uncomfortable to survive
The observation that any approach which reliably beat the market without periods of pain would be copied until the advantage disappeared.
It reframes underperformance from a sign the method is broken into the cost that keeps the method available.
Investors who abandon a value screen after two poor years are the reason the screen still has an edge for those who do not.
Know what you are looking for
Deciding on the specific characteristics that make a company worth buying before starting to look at companies.
Without criteria, screening becomes browsing, and browsing tends to select for whatever is currently in the news rather than for what is cheap.
A written checklist of the measures that matter turns a list of thousands of listed companies into a shortlist of a few dozen.
Value investing without forecasts
Ranking companies on measures that already exist in their published accounts, rather than on projections of what they will earn in future.
Forecasts introduce an error that is hard to measure. A backward-looking ranking is imperfect but at least its inputs are facts.
The formula uses reported earnings and reported capital, not an analyst estimate of next year.
Major contributions
- Reduced a large part of value investing to two published measures, making a systematic approach available to investors who cannot analyse companies full time.
- Documented special-situation investing, particularly spin-offs, as a distinct area where forced selling creates mispricing.
- Taught value and special-situation investing at Columbia Business School for many years, extending the school's long association with the discipline.
- Co-founded the Value Investors Club, which made detailed written investment analysis public and open to critique.
- Argued publicly that the main obstacle to a good strategy is the investor's willingness to hold it through bad years, not the strategy itself.
Major successes
- Founded Gotham Capital in 1985 and ran it as a partnership focused on corporate events and spin-offs, an area few institutions covered at the time.
- Returned outside investors' capital in the mid-1990s and continued investing privately, an unusual step in an industry built on gathering assets.
- Wrote The Little Book That Beats the Market, which became one of the best selling introductions to systematic value investing.
- Built a long teaching record at Columbia Business School, where his course has run for decades.
Important books
- You Can Be a Stock Market Genius1997
Despite the title, a technical book about spin-offs, restructurings and other special situations. Written for investors willing to do unusual work.
- The Little Book That Beats the Market2005
Introduces the magic formula in language simple enough for a beginner, with the arithmetic kept in the appendices.
- The Big Secret for the Small Investor2011
On why most individual investors struggle, and what a small investor can realistically do about it.
Influence on investors
Greenblatt did more than most to make value investing mechanical. By publishing a specific ranking rather than a philosophy, he gave individual investors something they could actually run, and screens built on quality plus cheapness are now a standard feature of retail investing tools.
His teaching at Columbia and the Value Investors Club also shaped a generation of professional analysts, and his insistence that a strategy must be painful to remain profitable is now a common way of explaining why simple methods are not arbitraged away.
Criticisms and debates
A balanced view includes the main criticisms and open debates, presented neutrally.
- The published back-tests behind the magic formula have not repeated as cleanly since the book appeared, and some researchers attribute part of the original result to how the tests were constructed.
- A mechanical screen cannot tell a genuinely cheap company from one whose earnings are about to collapse, so a formula portfolio will always contain some value traps.
- The method can underperform for several years in a row, which is long enough that most investors who adopt it will abandon it before it works.
- Return on capital and earnings yield can both be defined in several ways, and the results are sensitive to which definitions and adjustments are used.
- His special-situation work, unlike the formula, requires research skills, time and access that most individual investors do not have.
Lessons for investors
Plain-English takeaways. Context for learning, not advice to buy or sell anything.
- 1Decide what you are looking for before you start looking, or you will find whatever is loudest.
- 2Quality and price are two different questions, and a good investment usually needs an answer to both.
- 3Any method worth using will have stretches where it looks broken.
- 4A rule you can actually follow beats an analysis you cannot repeat.
Notable quotes
“Choosing individual stocks without any idea of what you are looking for is like running through a dynamite factory with a burning match.”
“Value investing works. Sit still and be patient.”
“A strategy that works most of the time but not all of the time is exactly what you should expect.”
Frequently asked questions
Who is Joel Greenblatt?
Joel Greenblatt is an American investor, author and teacher. He founded Gotham Capital in 1985, has taught at Columbia Business School for many years, and wrote The Little Book That Beats the Market.
What is the magic formula?
It is a ranking system that scores companies on return on capital, which measures business quality, and on earnings yield, which measures cheapness, then buys from the top of the combined list.
What are special situations in investing?
They are corporate events such as spin-offs, restructurings and mergers that change who owns a security. Greenblatt argued these often create mispricing because holders sell for reasons unrelated to value.
Does the magic formula still work?
That is disputed. Results since the book was published have been weaker and more uneven than the original back-tests, and researchers disagree about how much of the early result was method rather than market.
Why does Greenblatt say a strategy must be uncomfortable?
Because an approach that always worked would be copied until its advantage disappeared. In his view the periods of underperformance are what stop everyone from using it, which is what preserves the opportunity.
What can investors learn from Joel Greenblatt?
Common takeaways include knowing your criteria before you screen, combining quality with cheapness rather than chasing either alone, and expecting years where a sound method looks broken.
Which Greenblatt book should you read first?
The Little Book That Beats the Market is the accessible one and assumes no background. You Can Be a Stock Market Genius is technical despite its title, and covers spin-offs and restructurings that require unusual amounts of work to research.
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