In this interview on the [i3] Podcast, Rich Pzena discusses the one thing that Joel Greenblatt taught him which helped him to achieve outstanding results. Here’s an excerpt from the interview:
Pzena: He had one view right, he said to me I don’t believe in pure value investing. I think you should take the results that you had in your own record at Stanford Bernstein and go back and exclude the one-third of the portfolio that are the worst businesses that you can objectively measure, and he wanted me to objectively measure by the normal return on equity.
Take the companies who had the lowest one-third normal return on equity, exclude them, and I said it’s not going to make any difference. If you buy cheap stocks it doesn’t matter if they’re good businesses or bad, if you’re buying them for half price it works well.
I was wrong. I was completely shocked when I did that analysis. So he convinced me not that you should seek out the highest return on equity businesses but that you should weed out the lowest right, and now I sort of get it.
If you’re investing in companies that permanently… in their normal state barely earn their cost of capital, even if you’re buying them about half of what you think they are, their value is depreciating over time rather than appreciating over time.
So if you don’t get the timing exactly right it’s a wasting asset that you’re buying and and you’re just barking up the wrong tree.
You can listen to the entire discussion here:
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