A interview with value investor and author, Joel Greenblatt. In this interview, Joel discusses how he uses value investing in the modern markets and valuing FANNG or tech stocks. Joel also talks about growth investing vs value investing, making reference to the housing market at the RobinHood Conference
Joel Greenblatt: Value Investing, Valuing Tech Stocks And Growth Investing
Q3 hedge fund letters, conference, scoops etc
Also see our RobinHood conference coverage at the following links
- David Petraeus
- Lakewood Capital
- Joel Greenblatt
- Ken Griffin
- Ray Dalio
- Larry Robbins
- Joshua Kushner
- Dan Ariely
- Scott Ferguson
- Matthew Knauer
- Zachary Schreiber
- Alexander Sacerdote
- Trip Chowdhry, Lawrence J. Fossi aka Montana Skeptic, Gordon Johnson, Catherine Wood
- Investing In Cannabis
- Long Agriculture Panel
- Disrupting Retail & Quantamental Funds
- Lightning Round: All Shorts!
Transcript
So I want to remind everybody that you are a security investor which means that you buy individual stocks and in some cases sell individual stocks short. But the natural question many people would have for a value investor right now is this after a 10 percent or almost 10 percent selloff to the degree that you look at the market and decide whether it's cheaper or expensive.
Is it cheap. Sure. So we actually value all the businesses in the S&P 500 bottoms up and we have good data going back to 1990. So we can actually contextualize where do we stand today. According to the way we value our measures of absolute relative value that we use and we apply them consistently over the 28 years and right now we're in the 22nd percentile towards expensive over the last 28 years meaning the market has been cheaper 78 percent of the time more expensive 22 percent of the time. Now this isn't a projection but we can go back in time and look from this valuation percentile in the past what's happened over the next year or 10 and markets up 4 to 6 percent over the next year 10 to 12 over the next two. So subnormal meaning during that 28 year period market was up about 10 percent a year and were expensive or above average so four to six is closer to what's happened in the past over the next year. The market has repriced from its peak P.
By about 4 4 and a half times.
Do you see that as healthy. You know we don't really look at P E we're really looking at cash flows and so we're pretty consistent about that. And so market's gotten somewhat cheaper I mean it was down. Maybe towards the end of September it was probably down about the 14th percentile. Now it's back at the 22nd so it's dropped but it's not cheap. But then again how what could happen from here on the 22nd percentile with expected returns of 4 to 6 percent. One way to get back and no guarantee that we get back to those expected returns of 10 percent or so. But one way you could get back there is if the market fell 18 or 20 percent tomorrow the expected returns going forward from there would get closer to 10 percent a year. But that doesn't have to happen because if the market just under Urd meaning had some normal returns of 4 to 6 percent in each of the next three years then three years from now with a normal earnings trajectory would also be back to a 10 percent expected return. So it's really not helpful for me to know what's going to happen in the next few months but it is helpful from an investment standpoint of you know what are the prospects for the market in general and and how exposed when you're if you're really taking portfolio exposure to the market. Where should you be.
Joel tech stocks and in particular the Fang's have led this recent sell off. How cheap would those stocks have to get to appeal to a value investor like you.
You know it's it's interesting the things that were short or Joane trading in 50 or 100 times earnings or losing money. Those are your sort of choices of the things that were going to be shorting. So within that group will often be certain types of Fange stocks if they're not earning a lot of money yet and people are pricing it on 2024 earnings and they have a lot of high hopes involved there. And we're not really opining hundreds of stocks on the long side and hundreds of stocks on the short side. So the bucket of companies that are trading at 50 or 100 times pretax free cash flows or losing money. Historically that's the world's worst investment strategy. There will be some winners within that group and you'll actually know their names because they want. But I call that the tyranny of the anecdote. OK. It's really the world's worst investment strategy. As a group but some of them will win and you'll know their names because they won. But as a group it's a bad investment strategy so we're really concentrating on companies that have 7 8 9 percent free cash flow yields and a 3 percent interest rate environment. And while some of those may be priced cheaply because the people are a little concerned about the future even though they're earning lots of cash flow now we try to stick to companies that are gushing free cash flow huge returns on capital meaning they deploy their capital well that avoids some of the value traps from traditional value. And so I think that brings up the point we don't really think of value was low priced book low price sales investing. We're actually valuing businesses based on cash flows like a private equity investor would. And so if you're trying to figure out what a company is worth and buy it for less at a bigger discount that will never go out of favor even if traditionally no value as defined by Rossel or Morningstar which is low price book low price sales investing that may or may not go to stay in vogue it may be out of favor sometimes in favor may not even outperform the market going forward. That doesn't mean that much to me because those are sort of have been correlations that have worked with more than your fair share of companies that are out of favor I don't imagine they'll they'll come back at some point. But we're actually valuing businesses based on cash flows and that's what stops our ownership shares of businesses. There are early indications in recent weeks that maybe there's a shift. That may be the premium investors have given to growth stocks is coming off.
And perhaps they're beginning to appreciate value once again it's been about a decade since they genuinely appreciated value if not perhaps a bit longer. What are you seeing.
Yeah so while I say we're not traditional value investors and we're usually categorized by let's say a rustle or Morningstar as Blende as a Warren Buffett would say growth and value are tied at the hip. That's part of the valuation. So they put us in blend not traditional value but when growth is really going and these are the companies priced on hope and what's going to happen in 2024 2025 when those are doing really well they're probably not going to love what we're doing as much. In other words so we would ride a little more with traditional value. And so in those type of frothy markets that's not our market but those don't last forever. Prices have gotten pretty high. And like I said that doesn't mean that the Fange stocks or some of the names that you're familiar with won't do well or they won't meet the expectations that people think it's just that as a group the growth group where people just pay up for an expected growth over the next five years that's probably as you suggest have been a little frothy I would expect that to come back to Earth. Do you think the catalyst for that is going to be rising interest rates. I mean the real answer is I don't know. I would just say that it always happens in other words if the pendulum swings too much one way they'll be you know just like we had a correction in October that could happen things in general are more expensive than usual. But like I said that could play out in a lot of different ways. Market could fall 18 or 20 percent tomorrow or could just under earn it four to six percent a year for a few years. And that's the way it levels off meaning lower returns than than what. People have become but surely some things must.
Confuse you if you evaluate the market based on the things that you've observed in history the degree to which for example companies with bad balance sheets haven't been punished.
Yes so basically there's there's a reflexive component to that. One thing I did mention that the Russell 2000 which is the small cap universe that's in the sixth percentile towards expensive meaning it's been cheaper 94 percent of the time and when it's been here in the past year Ford returns have been about flat. So depending on what companies were talking about that is super expensive that should come back over time. It's usually not a good idea to lose money or buy things at 100 times pretax free cash flow is just bad idea.
Joel I want to ask you a question about factors. You're not a systematic investor but I wonder to myself if there's any way you would ever embrace systematic value investing. The reason I ask the question is because I know that you teach your students at Columbia to look at is security the way that they would consider buying a house. What if you were buying the neighborhood. Wouldn't you evaluate all the houses in the neighborhood on an aggregate basis and decide whether one neighborhood was cheap relative to another neighborhood being expensive and maybe the cheap neighborhood on aggregate was worth buying and maybe selling houses in aggregate in the expensive neighborhood. Because I hear you. Because and that's worked. Right so the statistics suggest that. Value was a factor outperforms growth that outperforms momentum at unperformed size it outperforms everything.
Right. But the way people describe value factor is low price book low price sales. I have no many ways to slice it right but the way that they're categorized by let's say a rustle or Morningstar is low price book low price sales and to me that's not a factor that we look at. OK. We're looking at cash flow so what happens when you're doing it on cash flow. I do. That's what we do. We value the businesses. Sure we're buying the cheapest and you know you brought up the house analogy so you know if you're buying a house it's pretty simple questions they're asking a million dollars. Your job is to figure out whether it's a good deal or not. So one question you might ask is if I rented it out I could get 70 or 80 thousand dollars a year net of my expenses and interest rates are 3 percent does that sound pretty good. How cheap is it relative to similar houses and all houses and all neighborhoods. So we look at a company and say how cheap is it relative to companies in the same industry. How cheap is it relative to all companies I can choose from. How cheap is it relative to how it's been priced over history relative to the market. These are measures of absolute relative value that anyone would use to value any earning asset. We can't value gold or bitcoin that way. And that's why we pass OK and value but earning assets there are standard ways that everyone would value them. And you know if you don't go crazy and you're very disciplined about it there's plenty of opportunities over.
