The Little Book That Beats the Stock Market by Joel Greenblatt
One Line Summary
Anyone can beat the market
Why it’s Awesome
Joel Greenblatt is a hedge fund manager after my heart. His writing style is simple and his ideas are profound. And as you might have guessed, this book is obtaining that mythical unicorn known as “beating the stock market”.
People have been trying to beat the stock market since the beginning of the stock market. It’s a testament to the law of averages that no one seems to have conclusively come up with a way of doing so. But in reality, why should it be that hard?
By beating the market, I mean that your returns on your stock portfolio are greater than if you had bought index funds. Since index funds are just the average of returns from all companies on the market, should it really be that hard to pick a portfolio of companies that on average are on the winning side of that equation?
Most people would tell you yes, it is. The market is incredibly volatile and arbitrage opportunities are absorbed in seconds. In fact, most mutual funds and hedge funds do not beat the market. So what chance does the average person have?
That’s where Greenblatt comes in.
Greenblatt argues that it isn’t hard to pick these winning companies IF you have faith in the system. This system he calls “the magic formula”. Cheesy, I know. But let’s take a look.
I won’t spill out all the details of the formula. What you need to know is that this system he describes looks for companies that are priced well (earning on investment) and well run (high return on capital). These two factors Greenblatt argues are the foundation of any great stock pick.
It’s almost too simple to be true. But Greenblatt runs the numbers and shows that had you indeed followed this formula, you’d not only beat the market, you’d destroy it. But the key is that you need faith. That is because this is a LONG TERM STRATEGY. It might take one year, two years or even three years. But eventually your returns will beat the market. And that’s because on average, the companies we are picking are those “winner” companies.
Mutual and hedge funds cannot often do this. They are judged harshly on short term returns. A bad quarter could mean the end for some funds because of the myopic nature of people and the level of competition.
If Greenblatt is right, the consequences are huge.
Why Does It Suck
Okay, so before everyone buys this book and starts trying this strategy, let’s take a more critical look at it. I don’t assume my readers have in depth finance knowledge so I’m going to skip that part. Let’s just use some common sense.
First off, I only read this book around a month ago and have yet to try this strategy for myself. So I am in no way endorsing Greenblatt’s method.
Second, there is not a whole lot of details for the calculations in the book.
Third, even though Greenblatt claims that mutual and hedge funds won’t be able to follow this strategy, I remain skeptical. Many hedge funds will lock their client’s investments for years. They also have the ability to tackle small cap stocks, which is where Greenblatt claims the bulk of gains from this magic formula will come.
Finally, anyone who claims to have a magic anything when it comes to stocks I immediately am skeptical of. It’s just too easy to make claims and generate some statistics to back your point, especially in the era of back-testing.
The Wrap Up
I am not saying Yes or No to Greenblatt’s strategy. I’m not your financial advisor. But from a reviewer’s perspective, this is a very informative and entertaining book about investing in the stock market. I highly enjoyed it, even if I never take on his “magic formula”.