Sunday 22 August 2021

The Big Secret for the Small Investor


This is the third book by Joel Greenblatt.  It is well worth reading.  He shares many good investing points in a short and easy to read book.  It was published in 2011, 1st edition.

What have I gathered from this book.

It is important to know how to value an asset.  Equally, it is important to pay much less than its fair value to own it.  Those are the fundamentals of investing safely.

He spent many good paragraphs on how valuation is indeed difficult, both for the professionals and the novice.  After spending a great deal explaining the many ways to value stocks (discount cash flow value, acquisition value, liquidation value and relative value), he concludes that these are difficult and not easy.  He gives many good reasons of how small changes in your judgements of various factors can lead to big changes in the valuation.  Also, one is often faced with a lot of uncertainties in many of your assumptions.  

I particularly like his section on earnings yield.   Buy using the earnings yield.  A company with a higher earnings yield is a better one than the other, assuming all else being equal.  He asks his readers to compare this with the risk free investment return, using the bond rate of the 10 years treasury bond.  Stick to a minimum of 6%, even if the present rate is much lower.  If the 10 years treasury bond rate is higher than 6%, for example, 8%, you should use the higher rate in your comparison.  He advises investors to aim for returns higher than the 6% in their investments.  Search for a company, a good company with a good business, that is available at a bargain and from your analysis can give a return of greater than 6%.  Find a second company using similar criteria.  Now you have 2 companies which you think are better than the treasury bond.   Compare the two companies to each other and invest into the better one.  This method is simple and practical; and it rhymes with the earnings yield method of Buffett where he treats his stocks as bond equity equivalents.

Another chapter on how much money to invest was particularly useful too.   How much money do you wish to have in stocks?   If you have 100% of your assets in stocks, will you be able to "stomach' a 40% decline in your portfolio value?  Perhaps, you should only have 50% of your assets in stocks and the rest in other different assets.  Then a 50% decline in your stock portfolio value will only caused a 20% decline in your overall total asset value, assuming your other assets were not similarly affected.  Maybe you can "stomach" this 20% decline without selling out of the stock market in panic.  The author advise each investor to decide on the percentage of their total asset to be in stocks, perhaps 40% to 80%.   For example, an investor may have 60% of his total asset in stock; at certain times he may increase this to 70% and at other times reduce this to 50%.  He caution that this adjustment should infrequent, preferably occur not more than once a year.  Also, no one should be completely out of the stock market at any time, as in the long run, stocks offer the best returns of all investable assets. 

Joel Greenblatt shares a good chapter on Behavioural Finance, another very important topic indeed.  All investors are wired poorly for investing, he mentioned.  They tend to panic and they tend to follow the herd for comfort.  Reading this chapter will certainly benefit many readers in their investing.

There are also many sections on investing in mutual funds, ETF, index funds and others.  Also, he has described well the different types of indexes which are market weighted, equal weighted and value weighted, giving their advantages and disadvantages.  Those who invest in funds will find this segment useful.

There are many valuable lessons I have learned from this book and hope you will find it likewise.  It is a small readable book.  It can be completed a few hours for a fast reader with some basic understanding of investing.

Not inappropriately, Joel Greenblatt is sometimes referred to as our modern day Benjamin Graham, the Benjamin Graham of the 21st Century.



Please read a good summary of this book here:

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