Joel Greenblatt on Relative Value Investing (Podcast)

and he ran that through two thousand and nine. He was one of the early investors in Michael Burry's hedge fund Michael Burry, made famous by both the book in the movie The Big Short, and he's now running Gotham Asset Management, which has put together a number of really interesting mutual funds, including a sort of value weighted SMP five index that has beat the index for a couple of year is running. It is not a traditional price

to book sort of value based tilt. It's all about future cash flows and moats and relative growth and value. Really the best way to think of it as a relative value tilts to the index. It's done really well. I always find Joel to be a fascinating guy. He understands the world of value investing better than most. His track record is simply outstanding, and he really has nothing to prove, nothing to sell. He's just a fascinating guy who's shot the lights out repeatedly. So, with no further ado,

my interview with Gotham Asset Managements Joel Greenblasts. This is Masters in Business with very Ridholts on Bloomberg Radio. My special guest this week is Joel Greenblatt. He is the principal and co founder c i O of Gotham Asset Management. He's been an adjunct professor at Columbia School of Business since He is the author of numerous best selling books, including You Can Be a Stock Market Genius and The

Little Book That Beats the Market. His newest book is called Common Sense, The Investor's Guide to Equality, Opportunity, and Growth. Joel Greenblatt, Welcome to Bloomberg, Thanks Perry. So let's start a little bit with the book common Sense. What first of all, what motivated you working in finance to write a book about opportunity, growth and equality? Seems to be a little different than your traditional value investing or is

it sure? Well, I'm a capitalist. I'd like it to to work well in investor in general has a certain way of looking at the world. And there are a lot of problems that capitalism has led to or the way at least we implement it. And and so there are certain things that seems fairly reasonable to me to suggest of tweaks we can make to the way the

system works now to make things better for everyone. And so you know, most people don't write this book from the perspective of a long term investor, and and so that's what I did here, and I hope it brings another perspective to solving some of these problems, particularly the ones that are very important to people now, including inequality and opportunity. So let's dive right into issues of opportunity. By page count, almost half the book, maybe even more,

is about education. So let's start. Let's start there. You you started a not for profit charter school in New York City in two thousand and six. Why did you do that and what did you learn? Well? Sure, well, the reason I did that is if you look at the statistics, if you are black, Hispanic, low income in one of our major urban centers, maybe the top fifty, your odds of graduating college right now are one out of a limit. We know that college graduates earn more

than high school graduates. High school graduates earn thirty more than dropouts. But that's that's huge, and it's not from lack of ability, and at least that's part of the reason that I got involved in the charter school space. Everyone has choice if if you have any kind of money in our system and you don't like the school in your neighborhood, you can move to a neighborhood with a good school, or you can send your kids to private school. If you don't have means, you get what

you get and you don't have a choice. And the idea behind charter schools, which just to define them, are publicly funded schools run not by the district, meaning run by independent operators. And it turns out that the charter schools in states where they have high standards of who gets to open one and who gets to keep running one or obviously if they're closed if they're not doing well, those tend to be the states like New York, Massachusetts,

and California where the charter schools do well. And so the idea was to set up a charter school in New York City and it's always okay or it's been done before. To open one school and put a lot of resources into it and make sure that it works well. And the idea behind this one was to do something replicable and the big hareat Decious goal when we got started was to open not one school, but forty schools.

My business partner John Petrie and I hired a woman Eva Moscowitz, who is the CEO UH and founder of the Success Network that I'm involved with, and today we have forty six schools and kids. And last year, according to the state tests in math and English UH, those twenty kids in all low income neighborhoods minority neighborhoods outperformed every wealthy district in the state, including Scarsdale, Great Neck and all the other tops UH just stricts in the state.

They would be the number one district. What's the lesson from that? What can we learn from charter schools and bring to public schools that are under performing well. I think the biggest lesson would be that it's not lack of ability that the kids aren't successful. The kids can do it. If you have high expectations, the kids can meet them. They just need the right supports and charters,

of course have some advantages over the district schools. They get to select their teachers and keep the ones that they think are doing a good job. They can pivot quickly to to only do what works or to improve things that aren't working, and they can do that very quickly. We spent more time in school at our charter than the district schools, so that's an advantage and big advantages. Parents choose to come, and so it's good to have the support of the parents, and that is an advantage.

In your book, Common Sense, you highlight p. S. One seventy two one of the country's best public school. It's run by Jack Spatola. What makes him such a special principle? Why is that public school not a charter school? Why is that succeeding so well versus the average public school in any big city. Right, So, the book, as you suggest, is not just about charters. It's about good schools anywhere,

giving good choices. Right, the the kids with the lowest UH family that meets, the families with the lowest means UH don't have a choice. So it's how can we make their district schools better? How can we give them choice of a good, good school choice, and they're certainly good district public schools. One that I highlight, as you suggest, Jack Jack Spatolas, the principal, he just retired for PS one SWO in Brooklyn, had to tell you how good a really good school can be. And this is a

district school. Uh. Of the kids, Uh past the math exam and past the English systam and in most other schools is below. But that's not the special thing. The special thing is that that passing math and passing English. What are the statistics for the students with disabilities at that school? Wow? So in other words, kids without disabilities did less than half as well in the in the regular district schools. That tells you how good that school is.

The English language learners passed the English exam at his school PS one seventy two in the regular district schools with nine, so ten times better. What can be done with the school, like Spatola is like PS one two that can be ported over to regular public schools. Of course that's the right question. Uh. And if you ask Jack Spatola, the principle, he would say, having high expectations

for every child, just keep looking. If something doesn't work for a student, find something else that that doesn't work, find something else, and keep working. But it's high expectations, expecting that each child, including students with disabilities, including impish language learners, can do the job with the right supports. So he would say that, but I would say that only one principle can be the best principle in the state.

It's probably Jack. It's very hard. It would be wonderful if the average principle could be this good, and we should strive to get there. But it hasn't happened. Uh. And I just point out that good charter schools, you know, with still you know that where kids poor and minority kids outperform the wealthiest districts, and a school like Jack's, where even the kids with disabilities are crushing it point out that the kids can do it. So the ten out of eleven who are not graduating college, it's not

from lack of ability. And so the question I posed in the book is what can we do for them? Because they can do the job. They can do the job, and so that's what I used them for. It's a big, big question you're asking, how do we move this? Uh, you know, Jack's success across the districts, and one of the sad answers is that not everyone can be Jack Spatola, but of course he should be studied, and so a real question should be why isn't what he's done studied

even more? And it's not. So that's a little sad. But right now it doesn't look like those ten out of eleven are being serviced. What can we do about that? Is what I read about in the book. Let's talk about one of the solutions. You write about alternative credentials. What are they and how would they work? Uh for for students coming from these disadvantage neighborhoods and schools? Yes,

so I I call it alternative certification. So I point out the ten out of eleven that the current system isn't working for, and I write in the book, uh, you know, I once posed this question when Tiger Woods was at the top of his game to my students at Columbia. I said, you know, how do you beat Tiger Woods? And my answer was don't play him at golf? And the idea that I uh suggest in the book

is something I called alternative certification. And so I'll give you an example Let's say you want to work in the HR department at Microsoft. What I'm suggesting is Microsoft should simply specify which tests, courses or certificates in lieu of a college degree that they would consider when judging applicants for a high paying job in that particular department. So these these things could include a simple literacy asked, an online course certificate program, or even a game based test.

UH Embolists, together with Mackenzie, has created game based tests that measured decision making in critical thinking skills. So it doesn't have to be a standard test. There's a lot of different ways you can test for talent. And so what I suggest in the book is that leading companies like Google, Microsoft, Amazon, JP, Morgan, UH, they wouldn't have

to create these tests or courses or administered them. What they would do is merely make public a list of which tests, which courses, which certificates would be considered in lieuisver college degree when selecting candidates for specific jobs. What's the hire for passing these things? That's when the whole ecosystem was developed. Sorry, well I was going to ask, what's the response been like from corporate America? Well, you know,

the book just came out. So I'm very hopeful, and one of the reasons I'm talking on your show, Barry, is to get this idea out there. UH. It's already starting in ways, but the idea behind it is once

there's a buyer. In other words, all these big, big companies have to do is make the list public what we will consider in lieu of a college degree, and then UH, the whole ecosystem hopefully will develop of supporting online resources and tutoring services UH would develop to help applicants pass these tests and courses and meet the new demand from these top companies. The great thing about this is none of it would require government involvement and the

cost would be much much lower than the current systems. Now, you might ask, what do you do for students with disadvantaged backgrounds from disdvan advantaged backgrounds, and I would assume there would also developed as long as there was this demand at the end of the day for passing these courses. Is that there would also be prerequisite courses that would develop as well, whether online or in person, teaching, and supporting resources that would all be rated like Uber drivers

and Airbnb rentals. Once again, none of it would require government involvement. They wouldn't be setting standards. Uh, they wouldn't need government funding. Now this is already starting. Google has already created six months certificate courses in a few technical areas, which if you pass, they'll consider your for a job.

But I'm suggesting something much simpler, where companies just set standards of which existing tests or new tests that they would look at, our courses or certificates that you could receive that they'll consider. So I think it would really jump start this whole sort of runaround, you know, in other words, don't play him and golf, run around the current system because it's just so unfair. This is what the ten out of eleven could try to pursue without

any government assistance. It's not ideal, it's not first choice. Of course, we want great schools and we could keep working at it. But this is something these major corporations can do right now. Set these standards, and then hopefully this whole ecosystem will get going. Quite fascinating. Let's talk a little bit about too big to fail banks. You wrote, quote banks are almost wired to get into trouble unquote. Explain, Well,

it's pretty straightforward. You know, money is spongible, So who pays the most of depositors, who lends money to borrowers the cheapest and with the easiest terms is who wins? Uh? The industry is competitive and it's very leveraged, So pretty straightforward. Why thanks are wired to get into trouble? So what can we do to make these banks no longer too big to fail? How do we make them safer for

both taxpayers and investors? Well, you know, in two after the two banking crisis, there are plenty of regulations, including dot frank, and it's made the whole system a lot safer than it was. But more regulations have very high costs. There's a lot of repercussions from a lot of regulations. You know, mostly only big banks can handle them. Smaller banks are dropping and closing like flies, and almost no new small bank charters are being applied for because small

banks can't afford all these regulations. Also, under the system, banks are penalized for making small business loans. It hits them from the new risk factors. So corporate bank loans under a million dollars dropped by sev two thousand eight, And we know what's happened to new business formation, it's way way down. The other problem is we also have

it solved too big to fail. The Mineapolis Feeds still came out with a study saying that it's still two out of three chance there will need another government bail out in the next century. And so we're hurting small businesses and small banks, and we have itself too big

to fail with all these regulations. So I write in the book about I tell a story about in the late eighteenth century early nineteenth century, UH, the English used to shift their prisoners to Australia, and in one of the earliest trips about prisoners died along the way, which was horrific. And so how would you solve a problem

like that. Well, obviously you could solve it with more regulations covering the medical care for the prisoners and food on board and safety and cleanliness, and put more government monitors on board. There's a lot of things you could do, uh to try to solve that problem. The other thing you could do is to change the incentives from the beginning and say to the ship captains, will pay you for the prisoners to get to Australia alive and well,

and will penalize to you for those who don't. Right, So it's setting incentives up from the beginning rather than micromanaging all the regulation. And so I suggest sort of the same thing with banks. You know, and a restaurant fails, the economy doesn't skip a beat. It's not true with banks. Uh, the financial systems too big, it's too intertwined, and and we need to do something right now. We're really the backstop. We do have to bail out the banks if things

turn bad, especially the biggest ones. And so one of the clear answers would be, if you know there's less than ten percent equity cushion in the banks. There have been a lot of things in Dot frank that, you know, go to risk controls, types of equity, things of that nature.

But I suggest in the book that if we've brought if we set the incentives up correctly up front, so that you have twenty to equity, and what I suggest is a new type of preferred, not not common equity, but to increase that ten percent common equity to twenty or thirty percent using a new type of preferential preferred, where the preferred is deductible for the bank, it's tax free for the holders. So obviously it's helping the banks.

But when things go back to the banks, if you now have thirty equity, anything that goes back to the bank's problems is like the restaurant failing. No one really cares. It's an equity holder, and I suggest the incentives are set up that both the board and management are incented by the combined value of the equity, and they preferred as if they're staple together is one security. So we

set the incentives up correctly. You still have a leveraged return from the common equity portion, but if there's any problems, it would be covered by the preferred holders. It sounds like we're giving a bonus to the banks to make this deductible for the banks and to make a tax free, But actually we won't have too Big to Fail anymore. Will help plenty of equity, and they'll cover their own. The losses will fall where they should, the incentives will

be aligned correctly. From the beginning, it's it's a pretty simple solution to a difficult problem. Right. That would require a little bit of legislation to both create that class have preferred, make it deductible to the bank, and make a tax free to the investors is and essentially you're asking the investing public to step in in place of the taxpayer to make sure banks have a big enough

capital cushion. Right, we're already supporting banks for good reason. Right, we already support them so that depositors don't lose their money and we don't have another depression. So this is more up front way of doing it. If we're just a backstop that's going to have to back stup in a crisis, we're there, but it's kind of hidden here. We take care of it up front. Yes, we're giving a benefit just for the preferred but we're very upfront about it. And we then align the incentives exactly how

they should be. That share hoopers, whether the preferred to common, will take all the losses, not the government. And this solves too big to fail because even if there's a major crisis and banks um lose their capital, it doesn't wipe them out. If I remember in the book, banks currently a running seven eight of capital reserve? Is that about right? They are? And I go, I go through the map, I mean, you know, with all the different risk controls, and and then there's uh subordinated debt that

turns into equity now. But I argue in the book that we're not going to really pull that lever. We're not going to force some big bank to convert its subordinated debt into equity, even though that's one of the options we now have. And and that's because it will cause a crisis of its own. It will cause a cascade. And that's what Neil Cashcarry argues too at the Minneapolis

head and I agree with that. So if we make this new type of preferred available, it becomes strictly voluntary for the banks to do it, or are they obligated to change their capital structure to have UM cap it all in reserve with this new type of preferred share class. Right, So if they want to be free of certain regulations that are protective otherwise, they can issue this preferred and

therefore take the risk themselves. Otherwise they'd be subject to a lot of restrictions on the type of loans they can make and things of that nature. So, which is stuff we're already doing quite fascinating. Let's talk a little bit about what's going on with young people today investing UM. What do you think of the rise of Robin hood investors. Is this a good thing or is this just board millennials at home without access to sports or socializing. Sorry,

I don't think it's a great thing. I think it is good to be exposed to investing for most people, and to be thinking about saving for retirement. But I uh, you know, when we saw on the internet bubble, you know, you know, trade and the other discount brokers, most of those people lost a lot of money. I think you're speculating with out knowing what you're doing is not a

great idea. And so you know, I wrote a book called The Big Secret, and I think you've heard me say it's still a big because no one bought that particular book. But it talks about the best performing mutual fund I wrote in two thousand eleven for the decade two thousand or two thousand and ten, and that one was a year when during a decade where the market was flat. Uh, Yet the average investor in that fund managed to lose eleven percent by moving in and out

at all the wrong time. And that's because people are emotional. If you don't really understand what you're investing in, you pile in When things are going well, you pile out when they're not going well. When something's working, you put more in. When it's not working, you put less in, and you do you make all the wrong moves, and I think when things turn around for these investors, it'll

end up not great. So you've been teaching for a long time, not only lecturing NBA students at Columbia, but you also UH teach a bunch of ninth graders at high school in Harlem. What's the difference between those two students and what do you try and communicate to each group? Sure, well,

it's an interesting question. You know. I taught a couple of years of the ninth graders for a semester and I tried to at a very early age, explained to them the concept of compounding, and I actually put on the UH front of their UH little notebooks and a compound interest example where if you start saving an age nineteen and you put in two thousand dollars a year, and you do that for seven years and you're in ten percent on your money and then you never put

in another nickel. You just do it for seven years starting at nineteen. The other example is you start at age in say two thousand dollars a year invested at ten percent and save for forty years, meaning put in two thousand dollars a year starting at age for forty years. The the person who started investing at nine teen and only put in seven payments of two thousand ends up earning more money just with seven payments by the time

they're sixty five. Then the person who started seven years later in age and put in four meat forty payments. So it just talks about how starting to save and invest early is very important, and so teaching it in ninth grade is important for students to understand that concept. My average NBA students already twenty seven, so of course they had a lot going for them, and so I'm not too worried about them. But it is a huge advantage to start early, and I made that very clear

to both sets of students. That's an astonishing data point that a seven year head start beats investing annually for the same amount for thirty years. What do you think of ideas that have been floated by people. The Governor of New Jersey floated the idea of baby bonds that we gift every person born in the United States of five thousand dollars in an account that they can't touch till they're either twenty five or or for college. What are your thoughts on on something like that. Well, I

do like, uh that idea. I think it takes advantage of compounding. I don't think it's nearly enough. I mean the statistics retirement savings UH, for most people are are pretty horrific. Nearly half of working age families don't have any retirement savings. UH. The median family between ages thirty two and sixty one have about five thousand dollars in retirement savings. The average working age, low income, Black, Hispanic, or non college graduate have no retirement savings. And here's

the terrible statistics. Nine intent families in the top fifth of the income chain have retirement savings. Nine intent in the bottom tip do not. So we need to do something. And if you earned between seven and thirteen dollars a year, or you earned I mean an hour or hand or twelve dollars an hour, which is about hourly workers do. But so security get you about nine thou dollars a year, so you need retirement savings. It's a real, real problem, and we don't have a system that really takes care

of that. So you know, what I suggest in the book is that, uh, compound interest is something that we can take advantage of that we don't. We're kind of blowing it as a country. And so right now, so security is really based on what you put in is

sort of related to what you get out. And so what I suggest is really putting into SoC Security gets capped at a hundred thirty seven thousand dollars a year, So I don't suggest raising taxes, but I do suggest that high earners keep contributing to their retirement above a hundred thirty seven thousand. They get to keep eight percent of it and then get the tax benefits of saving that.

So it goes into like a four or one K account, but the remaining fifteen or that they don't get to keep, that gets taken off the top now gets put into the count. Uh, the accounts of low earners and people just started working so they can take advantage of this compound interest at an early age. They don't have any savings outside of Social Security, and so I suggest a four one K type account for everyone at funded by

the higher earners. Yet the higher earners really are getting the tax benefit of being able to put their amount they put in above one thirty seven into their own tax advantage savings. So, uh, it's not really raising taxes, it's giving them advantage, but it's also helping out those who need it the most. So let me make sure I understand this, because this is kind of complicated, but

it's really very intriguing. Right now, your KER contributions, your Social Security contributions UM top out at about one thirty of any year. That number creeps up a tiny little bit each year adjusted for inflation. But effectively, if you're Jeff bezoso elon Musk, you top out on January one,

you're done paying FIKA for the year. What what you're suggesting is everything above one thirty seven or some percentage above one thirty seven you get to put into a four oh one K like funds over and above what

your current limitations are. Eight percent of what you move in goes in as if it's a pre tax investment, so when you take it out on the other end, you're not paying taxes, and twenty of it gets moved into a fund that gets put into individual investors, a similar for oh one K like funds that they manage and you start doing this for pick a year, twenty five year olds and younger. Uh So, in other words, you're planning about something to fix the looming retirement crisis

for year olds. Is that a fair assessment. Yeah, so it could start earlier than Whenever you start working and start paying in you get a big supplement. Everyone gets a four oh one take account, which I think everyone should have to take advantage of. Uh compounding, So we go to both young people and low orders, go to both. That's quite fascinating. Let's talk a little bit about something that hasn't gotten much press lately, and that's what we

do with immigrants in the United States. What advantages does the country get from a broader and more open immigration policy. Well, that's a great question, and of course immigration is a controversial topic. There's one area that's very clear and we're completely blowing that and it's skilled immigration. According to the Business Roundtable, we come in embarrassingly second to last among

developed countries welcoming skilled immigrants. The only country where better at uh at admitting skilled immigrants is Japan, and Japan literally discourages immigration. And not only that, you have to speak Japanese pretty much. You know the United States has a huge advantage. You know, English is the universal language of business and science. Uh, second to last is a really bad spot for US for skilled immiguration. And what's

the big deal about that. Well, you know, I disclosed in common sense the book, uh that skilled immigrants are actually in natural resources. We make, if you want to put it that way, half a million to a million dollars on each one of them and today's dollars and for everyone we take in. And what that is is the math of of those immigrants and their kids. That's today's dollars of how much they contribute versus how much

they get back from the government. So we make a half a million to a million dollars for each skilled immigrant we take in. We also get close to two jobs for people already here. So for every skilled immigrant we take in, they create two jobs for people already here. So we're not only get a pile of money, we also get two jobs. It's a it's a free gold mine. And I'll tell you why we should be encouraging it. Immigrants have founded of US startups over a billion dollars.

They're twice as likely to start a business as natives. As natives are UH they're responsible for a quarter of the productivity growth over the last twenty years, and immigrants are their children have founded two six of the fortune companies, which is pretty amazing. There was a data point in the book that I found astonishing. Microsoft had done an internal study and for each H one B one visa immigrant that they bring to the US to work for

them internally at Microsoft, they create four additional jobs. How on earth is that possible? That that just sounds astonishing. Well, you know, if you can get the best and brightest from around the world and hire someone like that, they need support and they create value. And so Bill that was a quote from Bill Gates that they did a study that at Microsoft. I said, across the country, it's two jobs for everyone we take in at Microsoft, I guess it's such a high level that they're taking and

they create four jobs. So it's pretty pretty exciting. The only problem is we don't encourage them to come. I said, we came in second to last. Our H one B program, which allows skilled immigrants to come in UH, is broken.

It's difficult, it takes a long time, it's expensive, it's very uncertain whether someone can stay as very limited we exceed our cap within about five three times our cap apply within the first five days of eligibility every year, So we're discouraging them from coming in, and we should encourage them. Countries by Canada Australia take anyone who will come who meet the government standard uh of skilled a bility,

you know, education and skill, and we don't. We actually actively discourage them, and we actually have a better system than they do. In some There was an article in Wired over the summer that discusses how Toronto has been feasting on tech workers that were frustrated with the U s H one B, visa programs and green card programs

in general immigration programs. Are we letting some of our most value creating and productive tech workers escape from America when we should really be much more welcoming and giving them a path to citizenship here? Yeah, I think that's pretty clear. You know, I talked about all the money we would you know, I called it a free goal mine. It's crazy we're throwing it away. I talked about all the money and the jobs we create by taking them in. But we actually have a system that should work even

better than kinda our Astralia. In Canada, Australia. They set government standards of who they'll let in, you know what, what kind of skilled labor. But that doesn't mean they're a good fit for a particular open job, or that these people are ambitious. They just are people who meet government standards. The way we work with the H one B is that there is an employer who actually wants to give you a job. So it's very direct. In

other words, it's a one to one perfect match. And so I suggest that we use that system that if an employers willing to pay someone sixty or seventy thousand dollars a year, uh, we can take as many of those as we want, as long as that employers willing to pay a tax uh on top of that salary in addition to that salary to the government, so you can take anyone you want. It ends up being cheaper than the current H one B program that's very long. It's much more certain. If you pay tax for five years,

you become eligible for a green card. Uh. You know, it's just unbelievable. I mean countries that opportunity and political freeman and safety things we have in spades, they have what's called a brain drain and we should be a brain magnet. We have liberty, we have freedom, we have safety, we have opportunity. So you know, the studies have shown that if you survey, immigrants were first choice second places Germany,

and we beat them four to one. So we should take every right person, take all that money, take all those jobs that these skilled immigrants bring in. I think it gets controversial because you know, we have the statue of liberty. It's very important. Uh, bring me your tired, your report. You know what about those secret refuge or better life? So I'm not addressing that with skilled immigrants.

But what I can say is this, We're gonna make so many money, so much money from taking you know, a better skilled immigrants program that we can actually afford to take in for each skilled immigrant, h one or two skilled immigrants, we can take eight or two and unskilled immigrants, you know, an afford to take them in. Or we can bring eight or ten of kids who are already here out of childhood poverty. So we can

do either one of those things. I don't want to get in an argument which is a better thing to do bring in more skilled immigrants, to give refuge to people who want a better life. Here in our country has been very important to our country, and I think that's important or to help the people already here. I don't want to get into the argument of what we should do with all the free money that we get by bringing in skilled immigrants. All I argued is we should take the free money. What do you do with

the searcharge over hiring? What where does that pool of capital go? Does that help the unskilled immigrants? Does that help anytime there's a big pile of cash, people get their eyes on it. What do you do with that money? Yeah, well I would I would put it into job training for the people already here. I would help, Uh, you

know employees already here. Obviously, with premium that you'd have to pay for a skilled immigrant, you would hire someone anybody who's here so that you don't have to pay extra. So you're really taking in people that you can't get here already. But there are people who need more training here. That's been a big problem. UH. As we know, UH, education is the answer. Job training is the answer to people who aren't earning enough here, and we can take

and put into very good use in that area. That's what I would suggest. How do you deal with some of the structural racism that's built institutionally into the United States that that Wired article I mentioned made reference to a number of programmers and other tech people who were people of color. And this was in both um the Virginia part of the country outside of d C. And outside of San Francisco. They felt that they were harassed by police because they look different, even though both areas

are filled with immigrants working in tech. And when the opportunity came to go to Toronto, they jumped on it. How big an issue is this, right, Well, in Toronto they had the chance for citizenship that they didn't have here under our current systems. So that's part of it. And this has been a problem across the world. You know, it's happening in Europe where people who look a little

different aren't very well absorbed into the local economies. We are the still the biggest melting pot in the world. So with all our problems, we still have it better than everyone else. Uh, And we can provide that opportunity to immigrants here. They still want to come here. It's still we're still the preference second place. Only a quarter of the people want to go to there's a hundred forty seven million skilled immigrants who want to come here. So, yes,

there are problems. I think we have less than many other countries, particularly in Europe, and I think we're bigger melting pot than any other country in the world. So I I acknowledge the issues. I'm not going to argue with them. I'm saying we're in comparison, we're still pretty good shape. We're we're still welcoming in general. Let's pivot to your bread and butter, value investing. You famously gave away the magic formula, which has a wonderful long term

track record. Um, but as we've seen over the past five years, value investing has struggled. What's going on in in value land? Well, you know, I gave a speech, uh you know in the last year called his value investing debt and my answer was yes, no, maybe, and I don't care. And the reason for that is it

really depends on how you define value. If you define it like Russell or morning Star, where's low price book, low price sales investing, it's had a tough time and in extraordinary time last five years, growth the way they define it at morning Star Russell has outperformed value by eleven percent per year the last three years, at seventeen percent per year growth outperforming value the last twelve months.

It's about these are phenomenal numbers. These are numbers bigger than during the five years before the top of the Internet pool. These are slightly bigger, slightly bigger to discrepancy between growth and value. So your question is is very good if you're define value like we do, which is figure out what a business is worth and pay a lot less. That's what I define as value investing. And you know Ben Graha would say leave a large margin of safety. Uh, then that's never really going to go

out of style. Uh. We we look at companies like we're private equity firm, No private equity firm, vis a business because it's a low price book or low price sales. They're really looking at cash flows. Okay, So while in a period like this where anything that's somewhat out of favor, Uh, even though it's not low price book, low price sales, they rhyme together. And if people are willing to pay growth at a price, then that's not going to be

a good theory for any style of value investing. But if either question is value investing dead or is it going to continue? It comes down to how you define it, and people will always come back to valuation. It's based on cash flows and how much those cash flows are gonna grow over time. As Buffet would always say, growth and value were tied at the hip. They're part of the same equation figuring out value. So once again we're

talking about definitions. So one of the interesting, um I don't want to call it post mortems, but analyzes on why growth has been doing so well relative to value over the past ten years is that in an era of low inflation and very low rates capital intensive industries like tech and growth, it's a very inexpensive input to them versus high inflation or higher rate regimes, value is present entered an opportunity to shine because it apparently needs

less capital. What what are your thoughts on those sort of analyzes of value versus growth these days? Right, Well, that's a great question. And so if you're talking about low price book investing, of course it's it's very relevant. If you're talking about cast flow oriented investing, uh, it gets a little bit more nuanced. So let me describe

it this way. For many many years before the last decade or so stoff that were low price book low price sales tended to have perform the market for periodittivetly forty years. And what that meant is that if you're buying a company close to its book value, me you aren't giving much of a premium to the value of the business underlying that purchase. Then if you want a bucket a company selling at low price book, you were tending to get more than your fair share of companies

that were out of favor. So it correlated well with more than your fair share of companies that were out of favor, and maybe two out of favor, and so you could get an access return. Uh same way as momentum has worked for thirty forty years, not just in this country but across the globe. But let's say it didn't work for the next two years. It could be that it's just cyclically out of favor. It works over

the long term, you just have to be patient. Or it could be momentum doesn't work over the next two years because the trade has become crowded and it's degraded, and that's why it didn't work two years from now. I wouldn't know the answer if it is momentum just cyclically out of favor, or is the trade now because it's not so hard to figure out if stock used to be down here and now it's up here. Has it become crowded and degraded because everyone knows about it

two years from now, I wouldn't know the answer. So the way I'd answer your question is this low price book, low price sales, momentum or all things that in the past had correlated with good returns. We really look for causation and since stocks or ownership shares of business and we're valuing them just like a private equity investor would, okay, and that's based on past flows, you know, or the

intention those earning money, they're not in earning money. Those are questions that translated to cash flow and how much my paying for that cash flow and how much my paying for that growth. And so you know, what we're looking for is valuation of a business, taking all those things into account and trying to buy that at a discount.

And it's possible the market doesn't recognize that. And you know, if you look at the last year, if you bought every company that lost money in two thousand two, twenties is a little messed up because of COVID in the second quarter had weird earning. So let's just look at

the companies that lost money in two thousand nineteen. If you bought every company that lost money in two thousand nineteen that had a market cap over a billion dollars and so they're about two d and sixty one of those, and you bought every single one of those companies, you'd be up sixty so far this year. Okay, So you know in that kind of market that's kind of fronthy at that end where people are going to say, hey, this company is gonna be the next Google, Microsoft or Amazon.

I don't think the office in the Google, Amazon and Amazon. Those are some of the best businesses we've ever seen in our lifetime. Uh to a large extent. They they don't quibble with their valuations. I actually we own a big chunk of those companies. We think they're great businesses. But there aren't hundreds of companies with that right with them. So it's really not looking at indexes or how do

we classify its value of growth. It's really looking stop by stop valuing them, trying to buy a discountant and that's causation. And so that causation might not be popular in the next year or two, but I'm not going to stop doing that. That's what stops on their ownership shares of businesses. So that's the best way I can answer your question. We're looking for causation, not correlation. We're not looking for that low press book, low price sales

momentum of correlated No private equity firm buys that. If I came to you and said, hey, listen, I have this real estate strategy. I'm just going to buy all the houses that were up the most in the last three months, you kind of look at me like I was nuts. And so although it's core it with good returns in the past, that's not what I would continue doing even though it's correlated. I'm looking for causation. That's the way I can put it. So let me throw

a correlation causation curveball at you. I have seen a number of studies over the years that point out that relative to their peers that don't do big stock buy backs, the companies doing share buy backs tend to outperform. Is that a correlation issue? Hey, they have all the extra cash and therefore they're good companies to begin with, so they could do buy backs, or there is some causal relationship between reducing the outstanding share account and that make

sure earnings appear better. What is the advantage or not of borrowing cheap money to buy shares back? Right, Well, what you're saying is true, and I haven't looked at the studies. But if what you're saying is true that buy back stock has correlated with good returns in the past, I would call that a correlation. Causation has to do with smart managements who only buy back stock when it's selling it a discount to what they think it's worth,

and they're right. So in other words, there's nothing inherently good or bad with buy backs. Some are smart when you're buying it below with the business is worth, and some are not so smart when you're let's say, borrowing money to overpay for your own stock. And so both of those things are true, and I wouldn't want to look at anything that's happened in the past and say, oh,

it's correlated with this or that. I would look at stock by stock and see if their buy backs were made a good prices relative to my assessment of value or where they were made at two high prices with borrowed money, and so they're totally different things. So I wouldn't put any weight into any study that just looked at generically companies that buy stops back. There's nothing inherently good or bad about it. It depends what price they pay.

Quite interesting. We've noticed the tendency amongst some of the companies you've referenced, like Google or Microsoft or Amazon or what have you, that it's become less of a competitive group of firms finding it out for a client's our customer, and more of a winner take all situation. What are your thoughts on those sort of winners and losers what Buffett describes as companies with impenetrable motes. Yeah, I mean

we own a lot of those businesses, you know. Uh, we have a uh fund that looks you know, buys the SMP five hundred, all five hundred stocks in the SNP five hundred, but overweights companies that we think are

cheap and underweights those. So it owns all five hundred but starts with the SMP index, which is market CAB weighted, and then overweights companies that we think are cheap and underweights those that we think are expensive by a little bit, so that doesn't have too much tracking errors, you know, sort of an index tilt. And we have overweighted almost all those companies that you're describing. They are some of the best business says in the history that we've ever seen.

We haven't seen anything like this before the power, and I think the Internet brings this power to these businesses. And these are moats that are very tough to be and so what you're suggesting is true. It is true. These are great businesses. They are dominating. It's very hard to break into them. And so I don't actually have a solution for should we break them up? Should we not break them up? As an investor, I'm investing in them. You want to be on the other side of the moat.

In other words, Right, if you really look at the cash flows and the stability of the cash flows and the growth prospects for the cash flows, these businesses are priced reasonably or cheaply, depending on which one. So that's not where the froth of the market is. The froth in the market is in the hundreds of companies that I was talking about before. That people will think will rhyme with the next Amazon, Google and Microsoft, and they're just can't be hundreds of company that do that. So

I think that's where they come up. It's will be. And so when you talked about the difficulty of value investing, that's fun that just overweights what we think is cheap according to our definition of value, and underweights has beaten the market. So even in a very tough period for value, it's not like the principles don't work. They do work.

But when you go long, short and short some of these names that are losing money or trading in hundreds of times that people think will be the next Amazon and Google, those I think are writing at very high prices and will have their come up, and so at least I hope so. And that's that's where I see the problem. So you deal with you manage money professionally, you deal with allocators and others. You're defining value in a way that's somewhat different than the way many value investors,

many less successful value investors, have done. So what do you say to those people who are ready to throw in the towel on value and think now is the time to jump into growth? Well, look, I don't buy, as I said, the traditional definitions of value and growth. The reason that we overlook with value some ofttimes, it's because we're certainly not growth at any price, you know, throw away the the rule book and just buy growth at any price. So sometimes we correlate closely with company

other companies that are out of favor. Uh. And and so those even Rustle and morning Star, will put us in the the either the blend category or the value category. That's usually where we are. We're certainly not quoth at any price. But I do think, uh, if you're asking me whether I think the traditional definition of value will come back at some point, yes, I do. I think I think it's gone to an extreme at this point.

I think it will come back. I don't really care if it does or not, because it's not our definition, but I do think it will come back. I think you should use a lot of managers allocators view traditional value as an asset class, meaning, hey, I should have some exposure here. It'sig and acts differently than the market. The returns and at some point they'll have their day

in the sun. And so I think people will continue to allocate there, but in a limited a more limited way because people chase what works, and it's clearly not been working traditional value. So imagine us five or ten years off in the future. If I were to ask you, hey, what was the one indicator, what was the one data point that was a signifier that value had come back?

What particular data point or variable might that be. That's a great question that I don't have a great answer for, mostly because of what I said about the definition of value. Uh So I guess what I would be looking for is companies that borrow a lot of money and lose money, don't have and and aren't the next Google in Amazon. There'll be some winners in that group, but most of them will have their come up. It's where a veg

full you have to earn money. That's where I think if some of those companies have their come up, and where as I said the money losers were so far this year, if those companies, a bunch of those companies have their come up, and so I would say that, you know, there's a chance for relative performance on companies that aren't like those, But leverage can answer it soon, right,

So leverage low low profitable companies. Some people would call that low quality versus high qualities at a ratio worth considering. You know, I hate making generalizations. I'm not trying to avoid your questions, but we really know, and I'm I'm trying to pin you down with a really general that wards looking a future forecast. A lot of people ask

that question. It's a reasonable question. I just don't have a great answer because we're looking at things stock by stock, and very hard to make generalizations about that, especially as I keep saying, we have different definitions. So for the record, let's get your best definition of the sort of value companies that you think have the best risk adjusted growth potential. What are the data points that you're looking at today, Not for a specific name, but you know, I'm giving

you an opportunity to restate the magic formula. Right, So what I would say is, right now, the pre tax cash flow yield of the SNP five is about four percent, little under four percent. So there are companies that have less than a four percent, you know, but much higher growth rate than the SMP in general. And there are companies that have a much higher yield you know, five or six or seven percent, that have at least as good, if not better fundamentals and growth rate than the SMP

five DRED. So both of those are relative values. There aren't a lot of companies out there that are super cheap right now. If you look historically, things are expensive. Obviously that has something to do with interest rates being lower than normal. It has something to do with the alternatives not being there for diversification and so stocks being one of the only games in town. So it certainly

has something to do with that. And if you told me that rates would stay permanently low, which I just don't know, then on an absolute basis, we could make some nice money from here. Otherwise I'm in the lucky position of people give me money and say I want to put it in the stock market. What's the smartest

way to do that? And so what we're sticking to our companies that maybe yield a little less than the S and T, but have much better growth prospects, much more secure earnings, stream great franchises, so we're willing to buy those. We're also willing to buy companies that we can get it much higher free cash flow yields than the market, that have at least as good growth, if not better, and better operating fundamentals. So both of those are areas that we look at and that's how we

would define at least relative value right now. And I think they could provide good value with great to stay the slow sounds good to me. I know we only have you for a few more minutes, so let me jump to my favorite questions we asked all of our guests in our speed round, and let's start with, uh, what are you streaming these days? Give us your favorite Netflix, Amazon Prime, or or whatever podcast you might be listening to. Well,

the two I've been watching lately. One is The Mindy Project because it's funny and we can all use that now, and the other is The Americans because it's just great drama. So I guess a lot of people are streaming during COVID, and you know it's been a horrible thing for so many people. But those are my two suggestions there. I'm gonna put those both on my list. Tell us about your early mentors, who who guided your career, who affected the direction you moved professionally? Well, you know, I have

to start with my dad. He was a businessman. He was a shumanufact actuer, and I learned ethics and actually how business works on a day to day basis at the dinner table he always shared with us. I got to work with him first a couple of summers, and uh, you know, someone I truly admire. He's still with us, and you know, I love him a lot, a great mentor. And then there's of course Graham and Buffett. You know, I went to Wharton, I was learning about efficient markets.

It didn't make much sense to me. I read an article about Ben Graham and then started reading everything that he wrote and everything about him. And then of course he mentored Warren Buffett, who made that little twist buying your good business chief that made him one of the richest people in the world. And both of those people shared what they learned with others. And it's one of the reasons I write, and one of the reasons I teach is because of their example. And so they've been

great early mentors for me. Let's talk about books. Tell us some of your favorite books and what are you reading currently? Well to most recent books I read, one was called The Splendid and the Vile by Eric Larson. It's about Churchill's first year in the office, which, of course, when things everything was going wrong, they put him in office days before it looked like England was going to fall, So how he handled that was really amazing to read

and great, great, great book. I love anything about Benjamin Franklin. So I just read the latest thing from Gordon Wood, the Americanization of Ben Franklin. So I enjoyed that very much. And if you haven't read much about Ben Franklin, that's what I would suggest. And then I read a book called Chasing My Cure by a doctor David Fagenbaum, who actually cured himself of a orphan disease that no one had lived from before. And he was in medical school

when he was diagnosed with this disease. They didn't know what was wrong with him, and it was going to be fatal in a few years. And the books called Chasing My Cure, and it show is how he actually cured himself and lots of other people that have this disease, and it was fascinating. And now he's attacking COVID in the same way. He's looking for existing drugs that may act well on something that doesn't have a drug of its own, and and so he's been working on that

and there was a very inspiring book. So that's called chasing my cure and believe it or not, it's a page turner. Sounds fascinating. What sort of advice would you give to a recent college graduate who was considering a career in asset management. Well, I don't want to be cliche, but if you're lucky enough to find something that you're passionate about that you can do for a living, that's a gift. Buffett called it dancing to work every day.

And the only people I would suggest that go into it are people who feel that way to go in to this business just for the money, you know, and many aspects of it pay pay well. I don't think it's a great choice, but if you really love it, you can help a lot of people with their investing, and you can do good things with the money that you do earn if you're successful at it. So I highly recommend it, but really only if you're passing it you love the work, so that would be my best advice.

Pick something else. There's a lot of ways you can contribute to society that don't involve asset management, So if you love it, I'm all for it. If you're doing it for the money, take something else. Our final question, what do you know about the world of investing today that you wish you knew when you started out thirty or so years ago. Sure, well, I got into investing reading Ben Graham and and one of the first articles I read what Warren Buffet would call cigar butt investing,

you know, buying net net stocks. And I actually wrote an article with some of my classmates, my master's thesis that was published in the journal Portfolio Management on net nets and they worked pretty well. And you know, as I said, Buffett made that little twist that made him one of the richest people in the world, even though he's a student of Grahams. He said, if I can buy a good business cheap even better, quality matters a lot, even more now than it did thirty years ago. You

need to invest in a good business. If you think about investing as not trading, but buying companies you're going to hold for a long time. Of course, you want to be in a good business that has a good franchise and grow for a long period of time. Of course, there's an art to figuring that out. But to the extent that you can concentrate in those areas and also

look for bargains, you know a combination of things. You don't want to overpay for those things, but if you can pay a reasonable or a chieved price for those things, Concentrating on quality is a key that I learned, probably I started about thirty seven or eight years ago. I probably learned that about thirty years ago, and I and that it's the most important lesson I've learned in that period of time. Quite fascinating. Thank you, Joel Greenblatt for

being so generous with your time. That was Joel Greenblatt. He is the author of numerous books, including Common Sense, The Investor's Guide to Equality and Opportunity. He is also the co founder ce IO of Gotham Asset Management. If you enjoyed this conversation, well be sure and check out any of our previous three hundred and something prior conversations. You can find that at all the usual places iTunes, Spotify, Overcast, Stitcher,

wherever finer podcasts are sold. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. Give us a review on Apple iTunes. You can check out my weekly column on Bloomberg dot com slash Opinion. Follow me on Twitter at Rid Hults. Sign up for our daily reads at rid Halts dot com. I would be room is if I did not thank the crack staff that helps put these conversations together each week. Reggie Bazil is my audio engineer. Atica val Bron is

our project manager. Michael Batnick is my head of research. Michael Boyle is my producer. I'm Barry Results. You've been listening to Masters of Business on Bloomberg Radio