In his latest interview with CFA New York, Joel Greenblatt discusses how to avoid value traps that appear to have a good margin of safety. Here’s an excerpt from the interview:
Greenblatt: We even like better high return on tangible capital businesses that can reinvest lots of money at those high rates.
If you can take your earnings and reinvest at high rates then you saw on average its 66%. The answer in not… is 30% return on tangible capital not as good as 60%. That’s actually the wrong question. 30% is really good. 60% is really good. Can I reinvest that 30%, and that’s a great business if I can reinvest a lot of money at 30% with a long runway, that’s like one of the great businesses of all time, comparing 60% or 30%, or whatever it is…
If the value of the business is growing over time that adds to your margin of safety. If it’s not a good business, and it’s a value trap, and the value is shrinking, what appears to be… oh it’s selling at six and it’s worth ten today, but we’re not in control of the business, and if that ten is shrinking over time your margin of safety is also shrinking.
But if you pay seven, and the value is ten today, but that ten is going to twelve your margin of safety… so the initial margin of safety doesn’t appear as good but over time it’s growing and you’re in a good business, that’s really what we’re looking for.
You can watch the entire interview here:
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