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What is the secret to us? They're merely uh ownership shares of businesses that we're trying to value and buy at a discount. I think the people who are successful at it a understand that and b really enjoy what they're doing. Uh if you don't lose money, most of the other alternatives are good. So that's one thing to think of.
In this video, Joel Greenblood reveals the simple framework behind his concentrated portfolio that delivered nearly 40% returns. He also breaks down how earnings yield and return on capital works together to identify extraordinary businesses and why this combo separates average investors from great ones.
I began the interview by asking Greenblat to distill a lifetime of being a successful value investor. What is the secret? Uh if there's any secret, I think it's in understanding what you're doing. And um most people don't think of stocks. They think of them as pieces of paper that bounce around and you put ratios on them or figure out difficult math problems with them.
And to us, they're merely uh ownership shares of businesses that we're trying to value and buy at a discount. Uh I think the people who are successful at it uh a understand that and b really enjoy what they're doing. I've uh been teaching for a long time and I would say my most successful students are the ones who actually enjoy the process of figuring things out.
So what does value mean to Joel Greenblat? Uh value means uh exactly that, figuring out what a business is worth and only buying it when it's worth a lot less. Ben Graham said figure out what something's worth. Uh buy it at a big discount. Leave a large margin of safety between those two. and and that's still the key to it.
It's not it's not more complicated than that. And and speaking of running a concentrated portfolio, Gotham Capital, the hedge fund that you co-managed with your longtime business partner from 1985 to 1995, um it did have a very heavily concentrated portfolio. I mean, six to eight names I I read somewhere.
Why did you take that approach to begin with? Why be that concentrated? Right. Uh that's a great question and it's really goes to the answer I just said that we we couldn't know companies very very well right if we had to know 50 of them we might have to go through 50 or 100 companies to find those six or eight that they're that are at the biggest discount to our assessment of value.
Uh but what comes with such a concentrated portfolio is that every few years one or two of your ideas you wake up and and they haven't worked out. You might lose 20 or 30% of your net worth in those few days. And if you have have outside investors, they're not too pleased about that. If you're working with a partner like I have, uh Rob Goldstein, uh we understand what we own.
We understand that it's just at a bigger discount if we haven't changed our opinion. Uh and so we're willing to stick with it. But not many people would. Uh the problem with I think giving money to idiosyncratic stock pickers is that uh I think investors don't know the logic that really went behind each investment.
All they really have are the numbers, the results. And unfortunately, uh, returns over the last 1, three, five years for managers don't have much to do with the next one, three, and five years. But that's all people look at. So that they're, uh, giving money to the people who have just performed the best, and they're taking money from the people who have performed the worst, but that's actually not what's going on.
What you really want to look at is process. Uh, are they evaluating and valuing businesses in in a uh, disciplined and effective way? Is there some green black, you know, golden rule or or approach that that enables you to to uh to invest in this again this very focused portfolio that that got you those 34% annualized returns when you were running Gotham Capital?
Uh, sure. Well, I actually wrote a book of war stories about things that I looked at. It was called You Can Be a Stock Market Genius. probably one of the most poorly worded titles ever, but uh in it I tried to really explain right uh how we go about doing things. So it was a compilation of war stories.
I mean one of the things I said in there was uh if you don't lose money most of the other alternatives are good. So that's one thing to think of. But mostly the book was about special situation investing. In other words, looking for things that are a little off the beaten path or a little complicated or just a little different um than what other people are looking at.
They're going a company going through extraordinary changes, something a little odd, something a little complicated, something a little different. So, I would not say to get those type of returns, we had to be the world's greatest analysts. We just had to look under a few different rocks where other people weren't looking at the time.
But it still all comes down to being able to value a business and uh buying it at a discount. It's just that why not turn the edge in your favor and look in places that other people aren't. Do you have a special situation that you're investing in now that that that would exemplify your approach? Well, frankly, what we're doing now in a very diversified approach is valuing businesses.
And so, uh, about six years ago, uh, Rob and I, my partner, uh, uh, we looked at each other and said, you know, picking, uh, doing an intense amount of work on just a handful of companies is a full-time job. Uh, covering a whole universe, a research universe of stocks, a few thousand stocks, uh, even with a nice analyst team and a very talented analyst team, uh, is also a full-time job.
And, um, we couldn't do both. And so we decided to go all in here. And part of it was that it was uh a little bit different than what we had been doing for several decades. The other part was there's a number of ways to make money. One is to be very concentrated in something you know well and that's what we had done for a long time.
And the other is to be right on average. Uh the benefits of what we're doing now is that as I told you before um if uh when we owned a six or eight stock portfolio and one or two of our investments weren't going our way, we might wake up and lose 20 or 30% of our net worth, right? Uh today with a more diversified portfolio, uh our bad days are 20 or 30 basis points of underperformance.
And so for most investors, the reason we decided to take outside money in again is uh our other uh approach was probably not appropriate if uh for most investors really can't take the volatility of the type of approach that concentrated approach uh and the best strategy for most people is the one they can stick with.
If I started I mean tearing up a balance sheet and an income statements and and if I were looking for is my starting point return on invested capital and earnings yield is is that that would be my first kind of cut. I think my first cut would be cheap. Okay. Uh and that would be the earnings yield portion of of what you're talking about, right?
Uh, you know, I don't live in Manhattan, but if I did, and I had a uh three-bedroom apartment, if it was available for $250,000, take my word for it, it would be a steal. At 50 million, it would be ridiculous. The apartment, the quality of the apartment hasn't changed. It's the price that determines whether something's a good investment.
So, you can't invest without price. And and and the second part, the return on invested capital, that's the good, whether it's good or not. and explain how you find return on invested capital. Sure. Uh well, the example I gave in uh my book, the little book, which which I really wrote for my kids to explain it, I gave two examples.
I said, think about you're building a store. Well, you have to buy the land. You have to build the store. You have to set up the displays. You have to stock it with inventory. And let's say all that cost you $400,000. And every year year, that store spins out $200,000 in profits. That's a 50% return on tangible capital.
Every business needs working capital. Every business needs fixed assets. How well does that business convert the working capital and fixed assets into earnings? Then I gave another example and remember it's for my kids and I right uh it's another store and I called that store just broccoli. It's a store that just sells broccoli.
Not a very good idea, but you still have to buy the land, build the store, set up the display stock with inventory. It's still going to cost you roughly $400,000. But because it's not a very good idea to just sell broccoli in your store, maybe it earns somehow $10,000 a year. That would be a 2 and a.5% return on tangible capital.
So, I would simply say I would like to own the business that can reinvest its money at 50% returns than 2 and a.5% returns. And and if you read through Warren Buffett's letters, he doesn't use uh that term return on uh tangible capital, but that's what I called it in the
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