In a wide-ranging interview, author and hedge fund guru Joel Greenblatt has responded to a myriad of reader questions on GuruFocus.com, offering his thoughts on portfolio strategy, macroeconomic analysis, and whether the potential popularity of his new website, FormulaTrading.com, will impact the success of his “Magic Formula”.
Greenblatt’s formula, detailed in his Little Book that Beats the Market, includes only two variables: return on capital and earnings yield. Despite its simplicity, it has a lengthy track record of beating the market by a wide margin, and our Validea.com Greenblatt-inspired portfolio is doing particularly well in 2009 (see below for its holdings). Here are a couple highlights of what Greenblatt had to say about his approach and a variety of other topics in his recent interview:
On when and why to sell: When to sell is always a difficult question. Big picture: I usually try to sell before my investment reaches a conservative estimate of fair value. In other words, I usually sell too early. In addition, I may sell before an investment reaches even that discount to conservative fair value if I find something else a lot cheaper and it makes sense to make the exchange after looking at my overall portfolio.
On whether he still believes in holding a concentrated portfolio: I still believe that for good business analysts a concentrated portfolio is a good strategy combined with a long term horizon. Actually, last year should give pause to people who think diversification among many stocks in an equity portfolio results in a significant degree of added safety versus owning stakes in a few well-chosen companies.
On whether the creation of his new FormulaTrading.com site will lead to more people using the Magic Formula, and lower returns: I have no concerns that FormulaTrading.com (soon to be renamed FormulaInvesting.com) will have an impact on future results of the Magic Formula. The formula appears to be very robust at all market cap levels including the largest market caps. Once again, the secret to success in following the formula strategy is patience, a quality in short supply for both professionals and individual investors alike.
On whether the last year has shown that macroeconomic analysis should play a role in stock investing: I think investors should have a large portion of their assets in equities over time. I don’t know too many people that are good at timing the market relative to macro-economic events. I think time horizon (which will be partially affected by a person’s age) should affect your allocation to equities. Over the last 10 years, while the market index has not performed well, the magic formula has continued to perform well on an absolute and relative basis.
As noted above, the Validea.com Greenblatt-inspired 10-stock portfolio (which is based on the approach Greenblatt laid out in his Little Book) has been on a tear this year, up 34.7%. Since its December 2005 inception, the portfolio has gained more than 20%, while the S&P 500 has lost 27.3%. Here are its current holdings:
