Legendary value investor and college professor Joel Greenblatt of Gotham Asset Management has a new book coming out called Common Sense. He sat down with ValueWalk to talk about his new book and about value investing.
This interview has been broken down into multiple parts. Click here for Greenblatt's views on immigration. Click here for his views on banking regulations. Click here for Greenblatt's views on education.
Joel Greenblatt: The problem with value investing
Greenblatt said the problem with value investing is not that it doesn't work. Rather, he said it's the definition of value investing that has recently come into use that doesn't work.
"It's very clear that… the way Morningstar or Russell define value has not worked over the last 10-12 years relative to growth," Greenblatt said. "So that's one definition of value; that's not our definition of value. It's related to cash flow. Figure out what a business is worth and pay less. That's our definition of value investing."
He explained that the other definition of value is to buy a company because it has a low price to book value. However, he looks at cash flow and how much cash flow will grow over time.
"As [Warren] Buffett said, growth and value are tied at the hip," Greenblatt added. "Growth is a part of valuation, so that's our definition of value, so it should never go out of favor."
Magic formula will still work in the long term
I also asked him whether the magic formula that he's very well known for still works, and he said it does. Greenblatt explained that there is a lot of speculation in the market right now, and that's not like how investors are valuing Google, Microsoft and Amazon, which he described as "some of the greatest businesses of all time."
He added that he owns the companies, and they justify their valuations because of their cash generating ability. Greenblatt said the speculation that's been going on has to do with soaring valuations of companies that lose money all the time.
"If you look at the 261 companies with a market cap of over a billion that lost money in 2019 before COVID and owned every single one of them, you would be up 75% year to date through September," he said. "That means there's an awful lot of companies losing money. People are pricing them like they will be the next Google, Microsoft or Amazon, so those kinds of companies are driving the market"
Greenblatt also said he wasn't saying that those companies don't deserve their valuations because they have great growth prospects and great networks and ecosystems. He added that among those companies that are losing money, there will be other Googles, Microsofts and Amazons, but not hundreds of them, as investors are valuing many money-losing companies.
This article first appeared on ValueWalk Premium.