Diary: Buffett, Greenblatt

Indecent Haste

Fascinating post on 09-Feb-2010 at Eurosharelab about Buffett's returns. I was vaguely aware of its existence before, and I was keen to get hold of the statistics, but could never seem to find them. Anyway, here they are:

Year             Value of $10,000 invested in             Value of $10,000 invested in   

                     Berkshire Hathaway stock                 the S&P 500 index

1971                       $10,000                                                 $10,000
1974                       $5,708                                                   $7,456
1975                       $5,422                                                   $10,229
1976                       $13,392                                                 $12,643
1991                       $1,361,805                                            $92,940
2008 (17 Nov)          $14,387,737                                          $259,068

Profit and Value Strategy

Sketch notes of article on 21-Jun-2011.

PAV (Profit and Value) Stategry differs from MFI (Magic Formula Investing) in its method of determining value and quality. PAV ises book-to-market for value, and GPM (gross profitability) for quality.

GPM = (revenues - costs of goods sold)/ total assets

PAV turns out to be a slight winner of MFI. Gross profits to assets is explored:

I think it’s interesting that gross profits-to-assets is as predictive as book-to-market. I can’t recall any other fundamental performance measure that is predictive at all, let alone as predictive as book-to-market (EBIT / (NPPE +net working capital) is not. Neither are gross margins, ROE, ROA, or five-year earnings gains).

GPM and PBV produce volatile results. Greenblatt:

it is partially the leverage embedded in low book-to-market that contributes to the outperformance over the long term.

(Side note:  this is very interesting! It could mean that a lot of the outperformance by Greenblatt is simply due to taking on more risk. This could be one of those "it works until it doesn't" strategies).

O'Shanaughnessy is cautious on low PBV:

it’s virtually impossible to buy the stocks that account for the performance advantage of small capitalization strategies.

 A market capitalization of $2 million – the cheapest and best-performed decile – is uninvestable. This leads O’Shaughnessy to make the point that “micro-cap stock returns are an illusion”

Blogger concludes:

I’ve now abandoned book-to-market

Excellent post by Greenbackd.

Diary

Joel Greenblatt lecture

Some notes taked from the scribd article published in Dec 2005.

Buy:

• good: high ROC: EBIT/( net working capital plus net fixed assets)
• cheap: high UEY = EBIT/EV 

EBIT is last 12-month's earnings beffore interest and taxes (maybe use operating profits).

More stocks worked out over one-year rolling periods, rather than two. 17-year annual return was 30.8%; using only the 1000 largest stocks, return was 22.9%.

Greenblatt's personal investment process

Look for value with a catalyst, so nice things happen sooner. Special situations is value investing with a catalyst. Try to figure out what "normalized earnings" will be in 3-4 years time. Ensure stock is cheap based on normalized earnings. 5-8 securities can make up 80% of portfolio. One position would be up to 30%. Concentration works well for "lazy" people. Always consider the downside. Usually spends one month or so to do research. For difficult situations, research could take months. If there is a great opportunity which wont last and they feel they understand it, they sometimes use "Ready, Fire, Aim!" [sic]. Has financials and utilities in the portfolio.

Considers EBITDA - MCX (maintenance capital expenditure) would be a better measure of earnings power, but can be difficult to calculate.

Dislikes shorting, saying that the long-short guys blow up every eight years. He calls it the "I got it! I got it! I ain't got it!" strategy.

Look for a big mess that seems too complicated, not well understood, not well followed, and requires too much work. Look for semi-complicated situations - the key is to identify what cuts to the core.

Prefer numbers over assessments of management. Bad signs are high salaries and insider selling.

Ignore the macro picture. Everything is cyclical. Values can always be found somewhere.

Ignore stock market prices and volatility - it's more important to be able to value companies.

There appears to be a movement towards high ROC comapnies. Low P/B have performed poorly over last decade. He doesn't know if/when the trend will reverse.

Greenblatt's secret to success is identifying situations (mainly corporate changes) which are not interest to the big players, but which offer a high upside potatnital.

Spinoffs

Greenblatt's favourite.

The intial price after the spinoff is usually unreasonably depressed, due to people jettisoning them. In corporate changes, determine where the interests of the insiders lie. A large stake in a spinoff implies high level of commitment. The credentials of the parent company are also important.

The spun-off company is generally some kind of drag on the parent company's valuation, and the spinoff usually even exciting, and may not even be that good.

Merged Securities

He warns against merger risk arbitrages (too many uncertainties, chance of being burned are high). Contrariwise, merged securities are more interesting. Often, the acquirer pays using bonds, preferred stock, warrants or rights. Insitutions typically shun these securities, and indivuals often quickly dispose of them. This drives down price.

Bankruptcies

The bonds, bank debt and trade claims of companies that are emerging from bankruptcies might offer opportunities. Care needs to be taken.

Restructurings

Invest after restructuring has been announced or when a company is ripe for restructuring. Analysts tend to drop coverage of these companies. Be sure you understand what's really going on, though.

Recapitalizations

Buybacks (aka recaps) [but he doesn't mention the scale of the buyback] create opportunities: it increases the leverage of the balance sheet, and the tax saving. "there is almost no other area of stock market where research and careful analysis can be rewarded as quickly and generously".

Greenblatt's poem

I'm reading The Big Secret for the Small Investor, by Joel Greenblatt. I love his witty comments about the post office:

Emblazoned across an entire city block on front of the building is the well-known motto "Neither snow not rain nor heat nor gloom of night stays these couriers from the swift completion of their appointed arounds"

Later, he notes:

Of course, during a recent snowstorm it turns out that it's "only a poem", according to our local postmaster.

A footnote states:

Actually, it's a poem written by a famous Greek historian 2,500 years ago (but only delivered in the last few centuries, due to some unforeseen weather conditions.