Joel Greenblatt: You’re Not The Next Buffett Or Lynch. Figuring Out Which Businesses Are The Great Ones Is The Tough Part

Joel Greenblatt

One of the best investing books ever written was – You Can Be A Stock Market Genius, by Joel Greenblatt. It’s a must read for all investors. There’s one passage in particular in which Greenblatt discusses the difficulty of making investment decisions like Warren Buffett or Peter Lynch saying:

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“The problem is that you’re not likely to be the next Buffett or Lynch. Investing in great businesses at good prices makes sense. Figuring out which are the great ones is the tough part.”

With that said, Greenblatt says you can still increase your chances of outperformance by investing only in what you know and understand.

Here’s an excerpt from the book:

Applying some lessons from the masters, at the very least, should help when the investment decisions become a bit more taxing. At most, since picking your spots is one of the keys to your success, following the basic principles of these investment greats should keep you focused in the right places.

All right, already. Where are these secret hiding places? Don’t worry. You don’t have to look under Love Canal or get shot down spying over some secret Russian military base. It’s not that straightforward. The answer is: stock-market profits can be hiding anywhere, and their hiding places are always changing.

In fact, the underlying theme to most of these investment situations is change. Something out of the ordinary course of business is taking place that creates an investment opportunity. The list of corporate events that can result in big profits for you runs the gamut—spinoffs, mergers, restructurings, rights offerings, bankruptcies, liquidations, asset sales, distributions. And it’s not just the events themselves that can provide profits; each such event can produce a whole host of new securities with their own extraordinary investment potential.

The great thing is, there’s always something happening. Dozens of corporate events each week, too many for any one person to follow. But that’s the point: you can’t follow all of them, and you don’t have to. Even finding one good opportunity a month is far more than you should need or want. As you read through this book, in example after example, in lesson after lesson, you may wonder “How the hell could I have found that one?” or “I never would have figured that out!” Both are probably true. But there will be plenty of others that you do find and can figure out.

Even after you learn where to look for new ideas, the notion that you can cover even one-tenth of these special corporate events is a pipe dream. On the other hand, making incredible profits over your lifetime from the ones you do work on, isn’t. The old cliche holds true: “Teach a man to fish. . . .”

What about all the other ways to get rich? There are no flaws in the investment methods of Warren Buffett or Peter Lynch. The problem is that you’re not likely to be the next Buffett or Lynch. Investing in great businesses at good prices makes sense. Figuring out which are the great ones is the tough part. Monopoly newspapers and network broadcasters were once considered near-perfect businesses; then new forms of competition and the last recession brought those businesses a little bit closer to earth. The world is a complicated and competitive place. It is only getting more so. The challenges you face in choosing the few stellar businesses that will stand out in the future will be even harder than the ones faced by Buffett when he was building his fortune. Are you up to the task? Do you have to be?

Finding the next Wal-Mart, McDonald’s, or Gap is also a tough one. There are many more failures than successes. Using your own experiences and intuition to choose good investments is excellent advice. It should be applied in every investment you make. You should invest only in what you know and understand. It’s just that Peter Lynch is an especially talented individual. It’s likely that he knows and understands more than you when it comes down to making the tough calls.

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Article by Johnny Hopkins, The Acquirer's Multiple

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About the Author

The Acquirer's Multiple
The Acquirer’s Multiple® is the valuation ratio used to find attractive takeover candidates. It examines several financial statement items that other multiples like the price-to-earnings ratio do not, including debt, preferred stock, and minority interests; and interest, tax, depreciation, amortization. The Acquirer’s Multiple® is calculated as follows: Enterprise Value / Operating Earnings* It is based on the investment strategy described in the book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias Carlisle, founder of acquirersmultiple.com. The Acquirer’s Multiple® differs from The Magic Formula® Earnings Yield because The Acquirer’s Multiple® uses operating earnings in place of EBIT. Operating earnings is constructed from the top of the income statement down, where EBIT is constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations. Similarly, The Acquirer’s Multiple® differs from the ordinary enterprise multiple because it uses operating earnings in place of EBITDA, which is also constructed from the bottom up. Tobias Carlisle is also the Chief Investment Officer of Carbon Beach Asset Management LLC. He's best known as the author of the well regarded Deep Value website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Articles written for Seeking Alpha are provided by the team of analysts at acquirersmultiple.com, home of The Acquirer's Multiple Deep Value Stock Screener. All metrics use trailing twelve month or most recent quarter data. * The screener uses the CRSP/Compustat merged database “OIADP” line item defined as “Operating Income After Depreciation.”

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