In this interview with Barry Ritholz, Joel Greenblatt defines value investing as determining a business’s worth and paying significantly less, rather than relying on traditional metrics like low price-to-book or price-to-sales ratios.
He argues that true value investing focuses on future cash flows and intrinsic business value, not stock market fluctuations. Greenblatt contrasts value investing with momentum investing, which he believes can be cyclically effective but lacks long-term reliability.
He emphasizes that stocks represent ownership in businesses, not just numbers in a portfolio. Ultimately, he believes many modern investment theories overlook the fundamental principle of valuing and purchasing businesses at a discount.
Here’s an excerpt from the interview:
Greenblatt: Right, well, my definition of value is to figure out what the business is worth and pay a lot less. It is not low price-to-book, low price-sales investing. If you took a look at MorningStar or Russell and they analyze what we do, they don’t put us in value as value investors; they put us in blend.
As Warren Buffett would say, value and growth are tied at the hip—growth is part of value. The way that it’s traditionally done and categorized is not my definition of value.
Traditionally, when people characterize these things—low price-to-book, low price-sales—those are factors that have correlated well in the past with higher returns cyclically.
Over time, it tends to work because, let’s say, low price-to-book—something selling close to its book value—just means people are giving a very high value to the business itself. They’re valuing it pretty close to the cost of the assets placed in the business and not giving much of a premium.
So you would tend to get more than your fair share of companies that are out-of-favor because they are priced low. But if you are a private equity firm trying to buy a business, you’re not buying it because it’s trading close to its book value.
You’re looking at cash flows, trying to project what they are going to be in the future, what you’re paying relative to that, and what it’s worth. It has nothing to do with low price-to-book or low price-sales; it really has to do with the cash flow-generating part of the business.
So, it does not bother me that traditional value, as defined by MorningStar, Russell, or whoever else, factors in attributes of individual stocks, whether it has or has not worked.
Here’s the big thing—the way I describe this is: Look, momentum has worked well for the last 30 to 40 years, not just in this country but across the globe, with one or two exceptions.
The reason we’re not momentum investors—there’s no argument about it—is that if it didn’t work for the next two years, it could be cyclically out-of-favor, and all we have to do is be patient, and it works over the long term. You just have to be a patient investor.
Or it could be that it’s not so hard to figure out—a stock used to be down here and now it’s up here. There’s plenty of data, computers, and research papers that say momentum has worked over 30-40 years. If it doesn’t work over the next two years, the trade may have become crowded and degraded. That’s why it didn’t work over the next two years.
And two years from now, I wouldn’t know whether it’s just cyclically out-of-favor or if the trade has degraded. That’s why I’m not a momentum investor.
The reason I’m a value investor, according to our definition, is that stocks are actually ownership shares of businesses that you value and try to buy at a discount. They’re not just pieces of paper that bounce around, where you put Sharpe ratios and Sortino ratios and use computer simulations to balance your portfolios.
Basically, they are ownership shares of businesses that you value and try to buy at a discount. It’s certainly possible that the market does not reward my valuations even if I’m right over the next two years, but that doesn’t mean we’re going to stop doing what we’re doing. Stocks are ownership shares of businesses, and that’s fundamental to the way we look at everything.
If you actually look at it in that way, you can see that modern portfolio theory and the way most academics, advisers, and managers look at the world just seems kind of insane—when you really boil it down to ownership shares of businesses that you’re trying to value.
Then you can sift through all the confusion that very smart people have created by putting a lot of numbers on the investment business that don’t make a lot of sense.
You can read a transcript of the entire interview here:
Joel Greenblatt Interview Transcript – Barry Ritholz
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