Lessons from the Legends: Joel Greenblatt

Joel Greenblatt is an esteemed professor at Columbia University (the only place I would consider doing a masters in anything finance related). He also is a very successful portfolio manager (the very rare breed of professors -- those with practical experience who care more about the real world than the theoretical).

For a top professor, you might expect he uses very complicated models or high level mathematics... well he doesn't:

"I look for obvious things when looking for bargains, not something terribly obscure ... wouldn’t involve higher mathematics or special sleuthing talents."

"When doing in depth analysis of companies, I care very much about long term earnings power, not necessarily so much about the volatility of that earnings power but about my certainty of “normal” earnings power over time. My goal is to buy a company at a low multiple to normal earnings power several years out and that the company earns good returns on capital at that level of normal earnings ... I usually just look at a simple multiple to normalized earnings. If I can buy something at a very low multiple and I have confidence in the earnings stream, I don’t have to calculate a DCF to know whether I want to buy it."

As you may have noticed in the video I posted on him in an earlier post, he uses a simple approach that works.

Proof that capital markets are NOT efficient

This is an exercise that I've stolen from Warren Buffett. It's entitled "The super investors of Graham-and-Doddsville."

Let's imagine we have 5,000,000 monkeys all taking part in a coin toss contest. The rules? Each monkey is paired with another and they flip a coin. The one to guess it correctly moves on to round 2 where it will face another monkey who also guessed correctly in round 1. This continues for 20 rounds where all the remaining monkeys are the final winners.

Since in each pairing, 1 monkey wins and 1 monkey loses (eliminated) we will end up with 1/2 the # of monkeys in each successive round. We also know that a coin toss gives you a 50% chance of guessing correctly.

Round 1: 5,000,000 monkeys remain
Round 2: 2,500,000 monkeys remain
Round 3: 1,250,000 monkeys remain
.
.
.
Round 14: 610 monkeys remain
Round 15: 305 monkeys remain
Final winners: 153 monkeys (do me a favour and forget that we can't have 1/2 monkeys .. just assume the numbers work out well)

So what are the odds of being one of the 153 final winners? Probability of 0.00305% (0.5^15). Basically extremely low odds. Think of this as a metaphor for investors now. Academics say that yes, there will be some major winners (such as Warren Buffett), but it's just a very low probability and entirely luck.

But what would you think if I told you that 100 of the 153 winning monkeys all came from the same zoo and had the same trainer? You would think that had something to do with them all winning! You would think they actually had better odds than the 0.00305% probability. Well this is what Warren Buffett argues is the case with value investors. Of the "unlikely" group of investors that consistently beat the market averages, a large majority of them are value investors following the principles of Benjamin Graham. Buffett goes on to show the records of several such investors/friends who all use value investing but have significantly different looking portfolios, but they all beat the market consistently.

How can the efficient market hypothesis hold water in light of this argument? "Buffett's argument has never, to my knowledge, been addressed by the efficient-market theorists; they evidently prefer to continue to prove in theory what was refuted in practice" - Seth Klarman

For more information, check out this WikiPedia page. I haven't checked the numbers given there to confirm they are correct but you get the point of the article.

Student Loans

I promised an informative post about student loans a while ago, but you're getting a bit of a rant about them for now.

I was on campus today and there was a big student initiated campaign against the cost of tuition/student loans. They claimed that student loans from the ~650 people who participated with them totaled a bit over $16.8 million. They claimed the average loan per student in our province is $26,680, up from $20,500 10 years ago.

They are complaining about this increase, which I look at and think it isn't very much given that its over 10 years. So I calculate it out, and it turns out to be an average increase of 2.67% per year. Seems about in line with inflation... what are they complaining about?

Moreover, no one is being forced to get student loans. If you don't want to be in debt, but you want a degree then you had better stretch it out over a couple more years so that you can work at the same time. I'm graduating this semester and guess how much student debt I have? ZERO. Now these people who got interest free (while in school) money from the government want their debt loads to be decreased? I'm starting to feel like the US home owner who was responsible with their mortgage/home only to see their irresponsible neighbour crying for help from the government because of their own stupidity/mistakes when the real estate market tanked in 2008.

Bad Internet!

While I'm still super busy with school, it's not as bad as during exams over the past week. The reason I've been inactive over the past few days is because my internet has been terrible!! I'm not sure if it's something wrong with my computer or just a shitty wireless router (I can't access it because I'm leasing). Either way it's driving me nuts to the point that I've been avoiding going online as much as possible.

I pay too much money to have such a bad internet connection...