Here is a plan. Let us develop a strategy that helps keep us from making our mistakes.

What we must also have is a plan for HOW MUCH to invest n the stock market in the first place.

It makes sense for almost everyone to have a significant portion of their assets in stocks.  Just as important, few people should put all their money in stocks.  Whether you choose to invest 80% of your savings in stocks, or 40% in stocks depends in part on individual circumstances and in part on how human you really are.

An investment strategy where 100% of your assets are invested in the stock market can result in a drop of 30%, 40% or even more in your net worth in any given year (of course, many people learned this the hard way in recent years).   Since most of us are only human, we cannot take a drop of this size without opting for survival.  That means either panicking out or being forced to sell at just the wrong time

In fact, if we start with the premise that we cannot handle a 40% drop, then putting 100% of our money in the stock market is a strategy that is almost guaranteed to fail at some inopportune time down the road.

Obviously, if we invest only 50% of our assets in stocks, a market drop of 40% would result in losing "only" 20% of our net worth.  As painful as this still might be, if we maintain the proper long-term perspective, some of us might be better able to withstand a drop of this size without running for our lives.

Whether you choose to place 80% of your assets in stocks or 40%, that percentage should be based largely on how much pain you can take on the downside and still hang in there.

Pick a number. What percentage of your assets do you feel comfortable investing in stocks?

The important thing is to choose a portion of your assets to invest in the stock market—and stick with it!  For most people, this number could be between 40 percent and 80 percent of investable assets, but each case is too individual to give a range that works for everyone.

Whatever number you do choose, though, I can guarantee one thing: at some point you will regret your decision.  Being only human, when the market goes down you will regret putting so much into stocks. If the market goes up, the opposite will happen—you’ll wonder why you were such a chicken in the first place.  That’s just the way it is. (Actually, according to behavioral finance theory, that’s just the way you is!)

So here’s what we’re going to do. Against my better judgment, we’re going to give you some rope to play with. Once you pick your number, let’s say 60 percent in stocks, you can adjust your exposure up or down by 10 percent whenever you want. So you can go down to 50 percent invested in stocks and up to 70 percent, but that’s it.  You can’t sell everything when things go against you, and you can’t jump in with both feet and invest 100 percent when everything is rocking and rolling your way. It’s not allowed! (In any event, doing this would put you in serious violation of our plan!)

Small investors will have a huge advantage over professionals

And here’s the big secret: if you actually follow our plan, small investors will have a huge advantage over professionals—an advantage that has only been growing larger every year. Of course, you would think that with all the newly minted MBAs heading to Wall Street each year, the proliferation of giant hedge funds over the last few decades, the growth of professionally managed mutual funds and ETFs, the increasingly widespread availability of instant news and timely company information, and the mushrooming ability to crunch massive amounts of company and economic data at an affordable price, the competition to beat the market would actually be growing fiercer with each passing year.  And in some ways it is.  But in one important way, perhaps the most important, the competition is actually getting easier.

The truth is that it is really hard to be a professional stock market investor today.  

It’s just that it’s really hard to look at returns every day and every month, to receive analysis every month or every quarter, and still keep a long-term perspective.  Most individual and institutional investors can’t do it.  They can’t help analyzing the short-term information they do have, even if it’s relatively meaningless over the long term. On the bright side, as the market has become more institutionalized and performance information and statistics have become more ubiquitous, the advantages for those who can maintain a long-term perspective have only grown.

For those investing in individual stocks, the benefits to looking past the next quarter or the next year, to investing in companies that may take several years before they can show good results, to truly taking a long-term perspective when evaluating a stock investment remain as large, if not larger, than they have ever been.  

Remember from early in our journey, the value of a business comes from all the cash earnings we expect to collect from that business over its lifetime.  Earnings from the next few years are usually only a very small portion of this value. Yet most investment professionals, stuck in an environment where short-term performance is a real concern, often feel forced to focus on short-term business and economic issues rather than on long-term value. This is great news and a growing advantage for individual and professional investors who can truly maintain a long-term investment perspective.

This focus on the short term by professionals is also a huge advantage for individual investors 

Luckily, since it’s particularly hard for most nonprofessionals to calculate values for individual stocks, this focus on the short term by professionals is also a huge advantage for individual investors who follow an intelligently and logically designed strategy.  Because value strategies often don’t work over shorter time frames, institutional pressures and individual instincts will continue to make it difficult for most investors to stick with them over the long term. For these investors, several years is simply too long to wait.

Hanging in there will be tough for us, too. But as individual investors, we have some major advantages over the large institutions. We don’t have to answer to clients. We don’t have to provide daily or monthly returns. We don’t have to worry about staying in business. We just have to set up rules ahead of time that help us stay with our plan over the long term. We have to choose an allocation to stocks that is appropriate for our individual circumstances and then stick with it. When we feel like panicking after a large market drop or ditching our value strategy after a period of underperformance, we can—but only within our preset limits. When things are going great and we want to buy more, no problem, we can—we just can’t buy too much.

So there it is. We have a strategy that beats the market. We have a plan that will help us hang in there. 

And, as individual investors, we have some major advantages over the investment professionals. All we need now is a little more encouragement. Perhaps a final visit with Benjamin Graham will help push us on our way.

In an interview shortly before he passed away, Graham provided us with these words of wisdom:

The main point is to have the right general principles and the character to stick to them.… The thing that I have been emphasizing in my own work for the last few years has been the group approach. To try to buy groups of stocks that meet some simple criterion for being undervalued—regardless of the industry and with very little attention to the individual company.… Imagine—there seems to be practically a foolproof way of getting good results out of common stock investment with a minimum of work. It seems too good to be true. But all I can tell you after 60 years of experience, it seems to stand up under any of the tests that I would make up.

After so many years, we still have an opportunity to benefit from Graham’s sage advice today.

We now have a great plan for how to invest in the stock market.

Finally, for the portion of our money that we choose to invest in the stock market, we should have a better idea 

1. of how company valuation is supposed to work, 
2. of how Wall Street professionals should work (but don't), and 
3. of how we can outperform the major market averages and most other investors.

Behavioural Finance: We are hardwired to be lousy investors.

1.  We are hardwired from birth to be lousy investors.

Our survival instincts make us fear loss much more than we enjoy gain.  We run from danger first and ask questions later.  We panic out of our investments when things look bleakest - we are just trying to survive!  We have a herd mentality that makes us feel more comfortable staying with the pack.  So buying high when everyone else is buying and selling low when everyone else is selling comes quite naturally - it just makes us feel better!

We use our primitive instincts to make quick decisions based on limited data and we weight most heavily what has just happened.  We run from managers who performed poorly most recently and into the arms of last year's winners - that just seems like the right thing to do!  We all think we are above average!  We consistently overestimate our ability to pick good stocks or to find above-average managers.  It is also this outsized ego that likely gives us the confidence to keep trading too much.  We keep making the same investing mistakes over and over - we just figure this time we will get it right!

We are busy surviving, herding, fixating on what just happened and being overconfident!  Maybe it helps explain why Mr. Market acts crazy at times.

2.  So, how do we deal with all these primitive emotions and lousy investing instincts?  

The answer is really quite simple:  we don't!

Let's admit that we will probably keep making the same investing mistakes no matter how many books on behavioural investing we read.

3.  How to invest in the stock market?

Traditionally, stocks have provided high returns and have been a mainstay of most investors’ portfolios. Since a share of stock merely represents an ownership interest in an actual business, owning a portfolio of stocks just means we’re entitled to a share in the future income of all those businesses. If we can buy good businesses that grow over time and we can buy them at bargain prices, this should continue to be a good way to invest a portion of our savings over the long term. Following a similar strategy with international stocks (companies based outside of the United States) for some of our savings would also seem to make sense (in this way, we could own businesses whose profits might not be as dependent on the U.S. economy or the U.S. currency)

4.  These words of wisdom from Benjamin Graham

In an interview shortly before he passed away, Graham provided us with these words of wisdom:

The main point is to have the right general principles and the character to stick to them.… The thing that I have been emphasizing in my own work for the last few years has been the group approach.  To try to buy groups of stocks that meet some simple criterion for being undervalued—regardless of the industry and with very little attention to the individual company.… Imagine—there seems to be practically a foolproof way of getting good results out of common stock investment with a minimum of work. It seems too good to be true. But all I can tell you after 60 years of experience, it seems to stand up under any of the tests that I would make up.

That interview took place thirty-five years ago. Yet we still have an opportunity to benefit from Graham’s sage advice today.

I wish you all—the patience to succeed and the time to enjoy it. Good luck.

Book:  Joel Greenblatt:  The Big Secret for the Small Investor (2001)

The secret to successful investing is to figure out the value of something and then pay a lot less!

Valuing a company you are investing into.

For simplicity, we will assume that the business in question will earn $10,000 each year for the next thirty-plus years.

Intuitively, we know that collecting $10,000 each year for the next thirty years is not the same as receiving all $300,000 today.  

Let us analyse and see what thirty-plus years of earning $10,000 per year are really worth to us today, using a discount rate of 6%.

Present value 

=  Annual Cash Flow / Discount rate

= $10,000 / 0.06 

= $166,667

(In reality, we should look for how much cash we receive from the business over its lifetime.  For the purposes in this post, we will assume that earnings are a good approximation for cash received.)

So, earning $10,000 a year for the next thirty-plus years turns out to be worth about $166,667 today.   

We have just figured out something incredibly important.  

A business guaranteed to earn us $10,000 each year for the next thirty-plus years or so, is worth the same as having $166,667 cash in our pocket today!

If we could be guaranteed that all of our assumptions were correct and someone offered to sell us the company for $80,000, should we do it?  If someone offered to give us $166,667 right now in exchange for $80,000, should we do it?  

Given all of our assumptions, the answer is easy:  of course we should do it!  

This is an incredibly important concept.  

If we can really figure out the value of a business, investing becomes very simple!  

The secret to successful investing is to figure out the value of something and then - pay a lot less!  

In fact, it couldn't be simpler:  $166,667 is a lot more than $80,000.

In practice, predicting so far into the future is pretty hard to do.

Are you really going to trust my predictions about what earnings will be over the next thirty years?

But will earnings actually shrink over those years?

Will they grow?

Will the company even be around in another thirty years?

In practice, predicting so far into the future is pretty hard to do.  In addition, many businesses are actually more complicated.

In fact, forget thirty years - it turns out that Wall Street analysts are actually pretty bad at predicting earnings for even the next quarter or the next year.  

You will probably pay less for those estimated earnings than if they were guaranteed.

Since no one rally knows for sure what earnings will be over the next thirty-plus years, whatever we use for estimated earnings during that time is just going to be a guess.   Even if this guess is made by a very smart, informed "expert", it will still be a guess.  

In practice, investors discount the price they will pay for future earnings that are based only on estimates.  

If there is no guarantee that you will actually collect that $10,000 after the first year of owning the business, you will probably pay less for those earnings than if they were guaranteed.  

In the above example, where next year's earnings of $10,000 were guaranteed, we discounted that payment by 6%, reflecting the fact that we had to wait a year to collect our $10,000.  Now, with only an estimated $10,000 coming in at the end of the first year, we will pay less.

How much less?  

That's not exactly clear, but we would certainly discount that hoped-for $10,000 by more than the 6% we used when the $10,000 was guaranteed - maybe we'd use a discount of 8% or 10% or 12%, or even more. (the amount of our discount would reflect in part how confident we were in our earnings estimate).  

But when we apply that higher discount to the next thirty-plus years of earnings estimates, that's when things really start to get silly (yes, it's true, math can be hilarious).

Value of the Company

At 6% discount rate

$10,000 /0.06 = $166,667

At 8% discount rate

$10,000 / 0.08 = $125,000

At 12% discount rate

$10,000 / 0.12 = $ 83,333

As it turns out, using a 12% discount rate, the value of the company is only $83,000.  We are starting to get in trouble!  It is no longer so obvious that a purchase price of $80,000 is such a bargain!

Figuring out the right discount rate isn't our only problem, we also have to estimate earnings. 

What is crystal clear, however, is that using different discount rates for our estimated earnings can lead to wildly different results when we try to value a business.   But figuring out the right discount rate isn't our only problem.  For simplicity, we have made some other assumptions that don't really hold up in the real world.  

For instance, as you might intuitively guess, most companies don't earn the same amount each year for thirty straight years.  Also, many businesses grow their earnings over time, while others due to competition, a bad product, or a poor business plan, see their earnings shrink or even disappear over the years.  

Let us see how funny the math gets when we try to value a business using not only different estimates for discount rates but we throw on top of that some different guesses for future earnings growth rates!

Value of the Business

At 4% growth rate, 8% discount rate

$10,000 / (0.08 - 0.04) = $250,000

At 4% growth rate, 12% discount rate

$10,000 / (0.12 - 0.04) = $125,000

At 6% growth rate, 8% discount rate

$10,000 / (0.08 - 0.06) = $500,000.

Annual Cash Flow / (Discount Rate - Growth Rate) = Present Value

According to finance theory and logic, the value of a business should equal the sum of all of the earnings that we expect to collect from that business over its lifetime (discounted back to a value in today's dollars based upon how long it will take us to collect those earnings and how risky we believe our estimates of future earnings to be).  

Will earnings grow at 2%, 4%, 6% or not at all?  Is the right discount rate 8%, 105, 12%, or some other number?   

The math says that small changes in estimated growth rates or discount rates or both can end up making huge differences in what value we come up with!

At 2% growth rate, 12% discount rate

$10,000 / (0.12 - 0.02) = $100,000

At 5% growth rate, 8% discount rate

$10,000 / (0.08 - 0.05) = $333,333

Annual Cash Flow / (Discount Rate - Growth Rate) = Present Value

Which numbers are right?

It is incredibly hard to know.  Whose estimates of earnings over the next thirty-plus years should we trust?  What discount rate is the right one to use?

The secret to successful investing is to figure out the value of something and then - pay a lot less.  

How are we going to figure out value?  How can anyone?  Do we have the answer yet?  Hopefully, we have learned some very valuable lessons even if we cannot answer them yet.

Summary:

1.  The secret to successful investing is to figure out the value of something and then pay a lot less!

2.  The value of a business is equal to the sum of all of the earnings we expect to collect from that business over its lifetime (discounted back to a value in today's dollars).  Earnings over the next twenty or thirty years are where most of this value comes from.  Earnings from next quarter or next year represent only a tiny portion of this value.

3.  The calculation of value in #2 above is based on guesses.  Small changes in our guesses about future earnings over the next thirty-plus years will result in wildly different estimates of value for our business.  Small changes in our guesses about the proper rate to discount those earnings back into today's dollars will also result in wildly different estimates of value for our business.  Small changes in both will drive us crazy.

4.  If our estimate of value can change dramatically with even small changes in our guesses about the proper earnings growth rate to use or the proper discount rate, how meaningful can the estimates of value made by "experts" really be?

5.  The answer to #4 above is - "not very."

Additional notes:

These concepts involve a discussion of the time value of money and discounted cash flow.  

In reality, we should look for how much cash we receive from the business over its lifetime.  For the above purposes, we will assume that earnings are a good approximation for cash received.

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:

https://frankploegman.blog/2011/10/30/the-big-secret/

Shift to Quality

Graham was too focused on price at the expense of quality.  Of course, this is an oversimplification.   Graham also took account of other factors, such as growth or stable results, although he didn't put as much emphasis on them.  

Most investors today pay attention to other drivers, such as growth or business quality, assigning increasing weight to them over time.



Philip Fisher

Philip Fisher played a pivotal role in the transformation undergone by many investors.  It was under the influence of his partner, Charlie Munger, that Buffett first became attracted to Fisher's philosophy.

Fisher put his money on investing in long-term growth stocks, with very robust competitive advantages that were capable of being sustained and increased over time.  The price paid for them was not as important, since if the company performed well it would be able to sustain a high multiple.  

This idea is less intuitive and therefore harder to digest than simply buying something cheap; it means paying seemingly expensive prices for something that will only yield results after a period of time.

This is ultimately the road that Buffett has gone down.  Thus, most value investors are also indirectly indebted to Fisher to some degree or another.

For those who have maintained a certain unshakeable bias towards investing in cheap assets, whose quality was not always proven, it can be a challenge to change their ways, especially when this mix had produced good results.

Every investor develops at their own pace.  



Joel Greenblatt

Joel Greenblatt's short book, The Little Book That Beats the Market, gives empirical proof that quality shares bought at a good price will always outperform other stocks.  

To do so, he classifies each stock according to two criteria: 

• quality, measured by ROCE (return on capital employed) and 
• price, measured by the inverse P/E ratio (price to earnings, the price that we pay for each unit of earnings).  [You can also use FCF yield, that is, FCF/price, instead of inverse P/E].

Greenblatt uses a numerical classification for both return and price:  1, 2, 3,4,...., with 1 being the stock with the highest ROCE under the return criteria and 1 being the highest free cash flow under the price criteria.   He then adds the points obtained by each share in both rankings to produce a definitive classification, which he calls the 'magic formula'.  

• The companies with the lowest sum of both factors deliver the best long-term returns.  
• Furthermore, the same is true throughout the ranking; companies situated in the lowest 10% post a better return than the second 10%, the second decile outperforms the third, and so on until the last 10%.

The exceptional results obtained by Greenblatt is surprising, but logical:  good companies bought at reasonable prices should obtain better returns on the markets.

The problem with applying this approach is that the formulas deliver over the long term, but they can also underperform for relatively long periods, for example, three years  this makes it though for both professional and enthusiast investors to keep faith when things are not working.

Joel Greenblatt: Value Investing for Small Investors

Greenblatt: Strategy Change

THE 10 BEST INVESTORS IN THE WORLD

Warren Buffett
Charlie Munger
Joel Greenblatt
John Templeton
Benjamin Graham
Philip Fisher
Mohnish Pabrai
Walter Schloss
Peter Lynch
Seth Klarman



Warren Buffett (1930)

"Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down."

Warren Buffett, born on August 30, 1930 in Omaha, Nebraska, is known as the world's best investor of all time. He is among the top three richest people in the world for several years in a row now, thanks to the consistent, mind-boggling returns he managed to earn with his investment vehicle Berkshire Hathaway. The funny thing is that Buffett does not even care that much about money. Investing is simply something he enjoys doing. Buffett still owns the same house he bought back in 1958, hates expensive suits, and still drives his secondhand car.

Investment philosophy:
 Focuses on individual companies, rather than macro-economic factors
 Invests in companies with sustainable competitive advantages
 Prefers becoming an expert on a few companies over major diversification
 Does not believe in technical analysis
 Bases his investment decisions on the operational performance of the underlying businesses
 Holds on to stocks for an extremely long period, some stocks he never sells
 Uses price fluctuations to its advantage by buying when undervalued and selling when overvalued with respect to intrinsic value
 Puts much emphasis on the importance of shareholder friendly, capable management
 Beliefs margin of safety are the three most important words in investing


Charlie Munger (1924)

"All intelligent investing is value investing — acquiring more than you are paying for."

Charlie Munger is vice-chairman of Berkshire Hathaway, Warren Buffett's investment vehicle. Even though Buffett and Munger were born in Omaha, Nebraska, they did not meet until 1959. After graduating from Harvard Law School, Munger started a successful law firm which still exists today. In 1965 he started his own investment partnership, which returned 24.3% annually between 1965 and 1975, while the Dow Jones only returned 6.4% during the same period. In 1975 he joined forces with Warren Buffett, and ever since that moment Charlie Munger has played a massive role in the success of Berkshire Hathaway. While Buffett is extrovert and a pure investor, Munger is more introvert and a generalist with a broad range of interests. The fact that they differ so much from each other is probably why they complement each other so well.

Investment philosophy:
 Convinced Buffett that stocks trading at prices above their book value can still be interesting, as long as they trade below their intrinsic value
 Has a multidisciplinary approach to investing which he also applies to other parts of his life ("Know a little about a lot")
 Reads books continuously about varied topics like math, history, biology, physics, economy, psychology, you name it!
 Focuses on the strength and sustainability of competitive advantages
 Sticks to what he knows, in other words, companies within his "circle of competence"
 Beliefs it is better to hold on to cash than to invest it in mediocre opportunities
 Says it is better to be roughly right than precisely wrong with your predictions


Joel Greenblatt (1957)

“Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.”

Joel Greenblatt definitely knows how to invest. In 1985 he started his investment fund Gotham Capital, ten years later, in 1995, he had earned an incredible average return of 50% per year for its investors. He decided to pay his investors their money back and continued investing purely with his own capital. Many people know Joel Greenblatt for his investment classic The Little Book That Beats The Market* and his website magicformulainvesting.com. Greenblatt is also an adjunct-professor at the Columbia Business School.

Investment philosophy:
 Buys good stocks when they are on sale
 Prefers highly profitable companies
 Uses the Normalized Earnings Yield to assess whether a company is cheap
 Beliefs thorough research does more to reduce risk than excessive diversification (he often has no more than 8 companies in his portfolio)
 Largely ignores macro-economical developments and short term price movements


John Templeton (1912 -2008) 

"If you want to have a better performance than the crowd, you must do things differently from the crowd."

The late billionaire and legendary investor, John Templeton, was born in 1912 as a member of a poor family in a small village in Tennessee. He was the first of his village to attend University, and he made them proud by finishing economics at Yale and later a law degree at Oxford. Just before WWII, Templeton was working at the predecessor of the now infamous Merrill Lynch investment bank. While everyone was highly pessimistic during these times, Templeton was one of the few who foresaw that the war would give an impulse to the economy, rather than grind it to a halt. He borrowed $10.000 from his boss and invested this money in each of the 104 companies on the US stock market which traded at a price below $1. Four years later he had an average return of 400%! In 1937, in times of the Great Depression, Templeton started his own investment fund and several decennia later he managed the funds of over a million people. In 2000 he shorted 84 technology companies for $200.000, he called it his "easiest profit ever". The beauty is that despite all his wealth, John Templeton had an extremely modest lifestyle and gave much of it away to charitable causes.

Investment philosophy:
 Contrarian, always going against the crowd and buying at the point of maximum pessimism
 Has a global investment approach and looks for interesting stocks in every country, but preferably countries with limited inflation, high economical growth, and a movement toward liberalization and privatization
 Has a long term approach, he holds on to stocks for 6 to 7 years on average
 Focuses on extremely cheap stocks, not necessarily on "good" stocks with a sustainable competitive advantage, like Warren Buffett
 Beliefs in patience, an open-mind, and a skeptical attitude against conventional wisdom
 Warns investors for popular stocks everyone is buying
 Focuses on absolute performance rather than relative performance
 A strong believer in the wealth creating power of the free market economy



Benjamin Graham (1894 - 1976) 

"Price is what you pay, value is what you get."

Columbia Business School professor Benjamin Graham is often called "The Father of Value Investing". He was also Warren Buffett's mentor and wrote the highly influential book The Intelligent Investor, which Buffett once described as the best book on investing ever written. Graham was born in England in 1894, but he and his family moved to the United States just one year later. His official name was Grossbaum, but the family decided to change this German sounding name to Graham during the time of the First World War. Graham was a brilliant student and got offered several teaching jobs on the University, but instead he decided to work for a trading firm and would later start his own investment fund. Due to the use of leverage, his fund lost a whopping 75% of its value between 1929 and 1932, but Graham managed to turn things around and managed to earn a 17% annualized return for the next 30 years. This was way higher than the average stock market return during that same period. In total, Graham taught economics for 28 years on Columbia Business School.

Investment philosophy:
 Focuses more on quantitative, rather than qualitative data
 First step is to look for stocks trading below 2/3rd of net current asset value (NCAV)*
 Prefers companies which pay dividends
 Looks for companies with a consistently profitable history
 Companies should not have too much long term debt
 Earnings should be growing
 Is willing to pay no more than 15 times the average earnings over the past three years
 Diversifies to spread the risk of individual positions
 Emphasizes the importance of a significant Margin of Safety
 Profits from irrational behavior caused by the manic-depressive "Mr. Market"
 Warns that emotions like fear and greed should play no role in your investment decisions

*NCAV = current assets - total liabilities



Philip Fisher (1907 - 2004) 

"I don't want a lot of good investments; I want a few outstanding ones."

Philip Fisher became famous for successfully investing in growth stocks. After studying economics degree at Stanford University, Fisher worked as an investment analyst before starting his own firm, Fisher & Co. This was in 1931, during the times of the Great Depression. Fisher's insights have had a significant influence on both Warren Buffett and Charlie Munger. Philip Fisher is also author of the powerful investment book Common Stocks and Uncommon Profits, which has a quote from Buffett on its cover which reads: "I am an eager reader of whatever Phil has to say, and I recommend him to you."

Investment philosophy:
 Dislikes technical analysis
 Does not belief in "market timing"
 Prefers a concentrated portfolio with around 10 to 12 stocks
 Emphasizes the importance of honest and able management
 Beliefs you should only invest in companies which you can understand
 Warns that you should not follow the masses, but instead have patience and think for yourself
 Companies should have a strong business model, be innovative, highly profitable, and preferably a market leader
 Has a focus on growth potential of both companies and industries
 Buys companies at "reasonable prices" but does not specify what "reasonable" is to him
 A true "buy & hold" investor who often holds on to stocks for decades
 Beliefs great companies purchased at reasonable prices and held for a long time are better investments than reasonable companies bought at great prices
 Has a "scuttlebutt" approach to doing research by asking questions to customers, employees, competitors, analysts, suppliers, and management to find out more about the competitive position of a company and its management
 Only sells when a company starts experiencing issues with its business model, competitive positioning, or management



Mohnish Pabrai (1964)

“Heads, I win; tails, I don’t lose much. “

Mohnish Pabrai has once been heralded as "the new Warren Buffett" by the prestigious American business magazine Forbes. While this seems like big words, you might start to understand why Forbes wrote this when you look at the performance of Pabrai's hedge funds, Pabrai Investment Funds, which have outperformed all of the major indices and 99% of managed funds. At least, that was before his funds suffered significant losses during the recent financial crisis because of their exposure to financial institutions and construction companies. Still, there is much we can learn from his low-risk, high-reward approach to investing, which he describes in his brilliant book The Dhandho Investor: The Low-Risk Value Method to High Returns.

Investment philosophy:
 Points out that there is a big difference between risk and uncertainty
 Looks for low-risk, high-uncertainty opportunities with a significant upside potential
 Only practices minor diversification and usually has around 10 stocks in his portfolio
 Beliefs stock prices are merely "noise"
 Used to buy reasonable companies at great prices, but now wants to focus more on quality companies with a sustainable competitive advantage and shareholder friendly management



Walter Schloss (1916 - 2012) 

"If a stock is cheap, I start buying." While Walter Schloss might not be the most well-known investor of all time, he was definitely one of the best investors of all time. Just like Buffett, Walter Schloss was a student of Benjamin Graham. Schloss is also mentioned as one of the "Super Investors" by Buffett in his must-read essay The Super Investors of Graham-And-Doddsville. An interesting fact about Walter Schloss is that he never went to college. Instead, he took classes taught by Benjamin Graham after which he started working for the Graham-Newton Partnership. In 1955 Schloss started his own value investing fund, which he ran until 2000. During his 45 years managing the fund, Schloss earned an impressive 15.3% return versus a return of 10% for the S&P500 during that same period. Just like Warren Buffett and John Templeton, Walter Schloss was known to be frugal. Schloss died of leukemia in 2012 at age 95.

Investment philosophy:
 Practiced the pure Benjamin Graham style of value investing based on purchasing companies below NCAV
 Generally buys "cigar-butt" companies, or in other words companies in distress which are therefore trading at bargain prices
 Regularly used the Value Line Investment Survey to find attractive stocks
 Minimizes risk by requiring a significant Margin of Safety before investing
 Focuses on cheap stocks, rather than on the performance of the underlying business
 Diversified significantly and has owned around 100 stocks at a time
 Keeps an open mind and even sometimes shorts stocks, like he did with Yahoo and Amazon just before the Dot-Com crash
 Likes stocks which have a high percentage of insider ownership and which pay a dividend
 Is not afraid to hold cash
 Prefers companies which have tangible assets and little or no long-term debt 10



Peter Lynch (1944)

"Everyone has the brain power to make money in stocks. Not everyone has the stomach."

Peter Lynch holds a degree in Finance as well as in Business Administration. After University, Lynch started working for Fidelity Investments as an investment analyst, where he eventually got promoted to director of research. In 1977, Peter Lynch was appointed as manager of the Magellan Fund, where he earned fabled returns until his retirement in 1990. Just before his retirement he published the bestseller One Up On Wall Street: How To Use What You Already Know To Make Money In The Market. Just as many of the other great investors mentioned in this document, Lynch took up philanthropy after he amassed his fortune.

Investment philosophy:
 You need to keep an open mind at all times, be willing to adapt, and learn from mistakes
 Leaves no stone unturned when it comes to doing due diligence and stock research
 Only invests in companies he understands
 Focuses on a company's fundamentals and pays little attention to market noise
 Has a long-term orientation
 Beliefs it is futile to predict interest rates and where the economy is heading
 Warns that you should avoid long shots
 Sees patience as a virtue when it comes to investing
 Emphasizes the importance of first-grade management
 Always formulates exactly why he wants to buy something before he actually buys something



Seth Klarman (1957) 

“Once you adopt a value-investment strategy, any other investment behavior starts to seem like gambling.“

Billionaire investor and founder of the Baupost Group partnership, Seth Klarman, grew up in Baltimore and graduated from both Cornell University (economics) and the Harvard Business School (MBA). In 2014 Forbes mentioned Seth Klarman as one of the 25 Highest-Earning hedge funds managers of 2013, a year in which he generated a whopping $350 million return. Klarman generally keeps a low profile, but in 1991 he wrote the wrote a book Margin of Safety: Risk Averse Investing Strategies for the Thoughtful Investor, which became an instant value investing classic. This book is now out of print, which has pushed the price up to over $1500 for a copy!

Investment philosophy:
 Is extremely risk-averse and focuses primarily on minimizing downside risk
 Does not just look for cheap stocks, but looks for the cheapest stocks of great companies
 Writes that conservative estimates, a significant margin of safety, and minor diversification allow investors to minimize risk despite imperfect information
 Warns that Wall Street, brokers, analysts, advisors, and even investment funds are not necessarily there to make you rich, but first and foremost to make themselves rich
 Often invests in "special situations", like stocks who filed for bankruptcy or risk-arbitrage situations
 Suggests to use several valuation methods simultaneously, since no method is perfect and since it is impossible to precisely calculate the intrinsic value of a company
 Is known for holding a big part of its portfolio in cash when no opportunities exist
 Beliefs investors should focus on absolute performance, rather than relative performance
 Emphasizes that you should find out not only if an asset is undervalued, but also why it is undervalued
 Is not afraid to bet against the crowd and oppose the prevailing investment winds
 Discourages investors to use stop-loss orders, because that way they can't buy more of a great thing when the price declines


Final words 

I hope you enjoyed reading how some the best investors in the world think about investing. You might have noticed some common themes, like buying companies for less than they are worth. And while they all practice this value investing approach, there are also notable differences between the strategies of these masters of investing. Where Warren Buffett runs a concentrated portfolio and focuses on "good" companies with a sustainable competitive advantage, Walter Schloss managed to earn impressive returns by simply buying a diverse set of extremely cheap companies. As Bruce Lee once said: "Adapt what is useful, reject what is useless, and add what is specifically your own.”


https://www.valuespreadsheet.com/best.pdf

The Little Book that Beats the Market by Joel Greenblatt

The Little Book That Beats The Market opens with a simple story about a boy selling bubble gum on the playground. The author and his son attempt to place a value on the business. In the end, it’s made clear that putting a value on a business is the key to investing in individual companies. 

The Magic Formula In A Nutshell

The book concludes with a multi-page appendix that lays out how to apply the magic formula. Here’s that explanation in a nutshell:

Go to a website that lets you filter stocks by certain criteria (like this one at Yahoo!). Filter for stocks that have a ROA (return on assets) of at least 25%, then rank them according to their P/E ratios, with the lowest at the top. Toss out all stocks with a P/E lower than 5 (something’s fishy there), all utility and financial stocks, and all foreign stocks. Buy five or seven of these stocks a month for five months (or so). When you near a year of owning one of these stocks, if it’s at a loss, sell it when you’ve owned it one day less than a year and if it’s a gain sell it when you’ve owned it one day morethan a year (playing games with the capital gains tax, basically). Then reinvest what’s left. Keep doing this for at least five years. That’s it!

Read more here:

http://www.thesimpledollar.com/review-the-little-book-that-beats-the-market/

Does the Magic Formula Really Work?

What You Will Learn

• Understanding what the Magic Formula is and how to use it
• Performance of the Magic Formula and whether it is achievable
• Whether the Magic Formula is worth using going forward

Magic.

That’s what you need to beat the market and that’s what the Magic Formula is supposed to do.

As a result of brilliant marketing, promotion and becoming a New York Times bestseller in 2005, Joel Greenblatt has turned the Magic Formula into a key strategy for many in the value investing and mechanical investing community.

Buy at least 20 stocks from the Magic Formula screening tooland then rebalance at the end of the year. Do this and you will beat the market, the book says.

The Little Book that Beats the Market

Greenblatt wrote The Little Book that Beats the Market for his children who were aged between 6-15 at the time.

It’s written in plain English and 6th grade math to make it easy to follow along. This is the strong point of the Magic Formula theme.

Everything is very easy to understand. The concept is simple, the explanation is simple, but most important of all, the execution for investors is simple enough to do on their own.

In it’s most naked form, the Magic Formula is described by Greenblatt as

a long-term investment strategy designed to help investors buy a group of above-average companies but only when they are available at below-average prices.

The Ingredients to the Magic Formula

Here is the formula courtesy of wikipedia. From beginning to end, it consists of 9 steps.

1. Establish a minimum market capitalization (usually greater than $50 million).
2. Exclude utility and financial stocks
3. Exclude foreign companies (American Depositary Receipts)
4. Determine company’s earnings yield = EBIT / enterprise value.
5. Determine company’s return on capital = ebit / (net fixed assets + working capital)
6. Rank all companies above chosen market capitalization by highest earnings yield and highest return on capital (ranked as percentages).
7. Invest in 20–30 highest ranked companies, accumulating 2–3 positions per month over a 12-month period.
8. Re-balance portfolio once per year, selling losers one week before the year-mark and winners one week after the year mark.
9. Continue over a long-term (3–5+ year) period.

Pay close attention to step 4 and 5 because they are the key driving formulas for it all to work.

• Earnings Yield = EBIT / Enterprise Value
• Return on Capital = EBIT / (Net Fixed Assets + Working Capital)

Earnings Yield is used because it targets companies with below-average prices. The idea behind of Return on Capital is to select good companies that are outperforming. This fits in line with what Greenblatt said

a long-term investment strategy designed to help investors buy a group of above-average companies but only when they are available at below-average prices.

The Magical Performance

So how magic is this Magic Formula in terms of performance? This table of values is from the revised 2010 version of the book.

and a better representation.

Starting with $10,000 the Magic Formula would have made you a millionaire by 2009.

The Magic Formula is famous for returning a 30% CAGR. From 1988 to 2004, it did achieve a 30.8% return, but the CAGR has declined significantly. No strategy can sustain a CAGR of 30%. Although the backtest in the book only provides data up to 2009, I wouldn’t count on 2010-2012 results showing vast out-performance.

The Magic Formula is a Fraud?

By popular demand, the Magic Formula will soon be added to the list of value stock screens, but the one thing that has held it back is the reliability of the backtest performed by Greenblatt.

I just don’t believe the results are as good as it seems.

What’s more, other blogs have tried to simulate the Magic Formula performance from the book, but none of them  have come close.

• Magic Formula that JUST beats the market
• Turnkey Analyst tests the Magic Formula
• Another article suggesting that the Magic Formula beats the market by 4.5%

Read more: http://www.oldschoolvalue.com/blog/investing-strategy/the-magic-formula-investing/#ixzz3cvbPJIfM

Joel Greenblatt’s Forgotten Original Magic Formula

Joel Greenblatt has one of the best records on Wall Street. Aside from being an adjunct professor at Columbia University Graduate School of Business, he's also well entrenched in the Hedge Fund industry through his management of Gotham Capital. From 1985 to 2005, Greenblatt is reported to have racked up an even better record than Warren Buffett did during his partnership days, earning 48.5% compounded over 10 years through a combination of special situation and deep value investing.

If you've heard about Joel Greenblatt, it's probably due to his widely read book, "The Little Book That Beats the Market". In it, Greenblatt makes the case for a formula that investors can use to achieve superior results over the long run. Essentially, the formula looks for businesses with a large earnings yield and a high return on capital. The premise is that, over the long run, stocks of firms that are both cheap and good would vastly outperform the stocks of firms that are just cheap -- and it definitely seems to have worked. As Greenblatt reported in his book, from 1988 to 2009 the magic formula produced a CAGR of 23.8% versus a 9.6% CAGR for the S&P 500.

The Original Magic Formula

Joel Greenblatt's love for cheap stocks of good companies started long before he developed his latest Magic Formula, however.

It's probably no surprise that the backbone of Joel Greenblatt's original magic formula rested on Benjamin Graham's net net stocks strategy. Greenblatt had been following Graham for years, carefully studying the principles and philosophies of the Dean of Wall Street, and was deeply impressed by, in his words, "the dramatic success of companies that the market priced below their value in liquidation...".

Benjamin Graham's own NCAV stocks strategy was to buy a diversified list of net net stocks that were trading at least 1/3rd below their net current asset value. Graham screened out stocks that failed to show a decent past record and those that were losing money. By putting together a diversified list, Graham hoped to take advantage of the population returns of net net stocks and ride that fantastic statistical record to great profits.

In 1981, at just 24 years old, Joel Greenblatt teamed up with Richard Pzena (a great value investor in his own right), and Bruce Newberg to test their own version of Graham's NCAV investing approach. The result was a fantastic research paper called, "How the Small Investor Can Beat the Market: By Buying Stocks That Are Selling Below Their Liquidation Value" (The Journal of Portfolio Management 1981.7.4:48-52).

Defining Net Current Asset Value

According to Joel Greenblatt:

Current Assets (Cash, Accounts Receivable, Inventory, etc.), less…

Current Liabilities (Short Term Debt, Accounts Payable, etc), less…

Long Term Liabilities (Long Term Debt, Capitalized leases, etc), less…

Preferred Stock (Claims On Corporate Assets Before Common Stock)…

Divided by the Number of Shares Outstanding…

Equals Liquidating Value Per Share (NCAV Per Share).

In his paper, Joel Greenblatt wondered what would happen if he carved up the world of net net stocks even further, eliminating a lot of the terrible firms from contention. To do this he turned to one of the most widely recognized valuation metric in value investing: the PE ratio.

Using both Graham's net current asset value and value investing's classic PE ratio, he put together 4 different portfolios and compared those portfolios against the OTC and Value Line's own value index from 1972 to 1978. According to Joel Greenblatt, this period was characterized by an extreme amount of volatility which made for a much more robust test.

To select the stocks, Greenblatt only looked at firms in the Standard and Poor's Stock Guide with market caps of over $3 million and names that started with either an A or a B. He then drew net net stocks from the roughly 750 candidates left in order to put together his model portfolios.

Portfolio 1 Price below NCAV PE floating with corporate bond yields No dividends required	Portfolio 2 Price below 85% of NCAV PE floating with corporate bond yields No dividends required
Portfolio 3 Price below NCAV PE of less than 5x No dividends required	Portfolio 4 Price below 85% of NCAV PE of less than 5x No dividends required

Purchases were made based on the above criteria. Stocks were sold after a 100% gain or two years had passed, whichever resulted first. The portfolios themselves were equal weighted, so the actual yearly returns of each portfolio were just the average returns of the stocks within each portfolio.

All of the portfolios beat the indexes by a wide margin. By combining liquidation value with smaller PE ratios, however, results exploded.

Take a look at portfolio #4. The CAGR of portfolio #4, Greenblatt's original Magic Formula, blew the market away. While the OTC CAGR totalled just 1.3% for the 6 year period, and the Value Line index came to a slight loss, Joel Greenblatt's original Magic Formula was up over 42% compounded per year from August 1973 to April 1978!

Greenblatt et al even included returns after commissions and taxes, for those of you who aren't holding your portfolio in a tax free retirement account for some strange reason. Re-examined, Greenblatt's best performing portfolio still destroyed the market, up over 29% versus flat returns for the indexers.

It's important to realize what this means for average investors. Since the American market indexes return roughly 10% per year on average, Greenblatt's forgotten original Magic Formula should be good for between 29% and 39% on average over the long run.

Granted, Greenblatt's study only covered a period of 6 years, but in my experience buying net net stocks with tiny PE ratios has proven to be a very profitable strategy. In fact, most of my best performing stocks have been these sort of net nets. Also keep in mind just how tumultuous the markets were during that period which, as Greenblatt wrote, made for a much more robust test.

(As an aside: if you're stuck holding your funds outside a tax shelter, for some reason, you can boost the tax efficiency of your portfolio by just holding your stocks for longer. This becomes a lot more viable if you're investing in the highest quality net nets.)

Three Major Takeaways from Joel Greenblatt's Study

It's hard to argue with returns like that.

Still, the more observant of you might have noticed a few potential flaws with the study and results.

At first glance, it definitely appears that you can't hold a large number of stocks in a portfolio using Joel Greenblatt's criteria. If you look to the right of each period's return, you'll see exactly how many stocks he held. In fact, Greenblatt et al were out of the market entirely for a lot of 1972 and 1973.

I don't think this is a crippling flaw to his strategy at all, however.

It's important to realize that Benjamin Graham's obsession with wide diversification isn't really necessary. In Joel Greenblatt's first book, "You can Be a Stock Market Genius," he argues that you need fewer than 10 stocks to eliminate most of the systemic risk that you face while investing in stocks. Ultimately, you don't need 30 or 100 different stocks to diversify away most of your risk. You can do it with ten.

You can even leverage Greenblatt's original Magic Formula, portfolio #4, while maintaining a fully stocked portfolio during the upper reaches of a bull market. The trick is to put together a portfolio of other net net stocks and then replace the weakest links in your portfolio with a portfolio #4 type net net when new candidates become available. Doing so would allow you to leverage the returns of NCAV stocks as a group while still employing Greenblatt's original magic formula when available.

You could even chose the best net net stocks that don't meet Greenblatt's criteria by focusing on NCAV stocks that are trading at an incredibly cheap price to NCAV, have no debt, are growing NCAV per share, are buying back stock, or which have insiders who are buying big blocks of shares, themselves.

Lastly, remember that Joel Greenblatt et al only looked at companies with names that began with the letters A or B. That inevitably eliminated most net nets from contention. In my own experience, there are a lot of net net stocks available for smart investors willing to invest internationally. I send many of these stocks out to those who requested free net net stock ideas.

The second takeaway is that both quality and price have a major impact on returns. Looking at the results, when holding PE requirements constant, the cheaper portfolios in terms of price to NCAV outperformed the more expensive portfolioes. Likewise, when holding price to NCAV requirements constant, the portfolios that demanded more earnings for the price paid outperformed their peers. By combining both value and quality, as Greenblatt did in portfolio #4, an investor can do very well in the stock market.

Finally, it's fairly clear that Joel Greenblatt's original Magic Formula, and NCAV stocks in general, trumps Greenblatt's contemporary Magic Formula. Sure, the Magic Formula that Greenblatt champions in his latest book is a good investment strategy, on the whole, but it just doesn't live up to his forgotten original Magic Formula. While his contemporary Magic Formula was reported to return just north of 23% per year vs. the S&P 500's 9.6% return, Greenblatt's original Magic Formula spanked that return -- and did so during a flat market, as well!

 How I'm Leveraging Greenblatt's Original Magic Formula

As you can see, Greenblatt's original Magic Formula is magical indeed.

His study has had a huge impact on my own selection criteria. When selecting net net stocks, I look for firms that have a deep discount to NCAV but still focus on high quality situations. For example, I currently own two deeply discounted stocks based on NCAV and earnings: one trading at just over 5x earnings and just over 40% of NCAV; the other offering a PE of 6 and trading at 68% of NCAV. Joel Greenblatt would be proud.

The biggest challenge to earning 25-35% annual returns is not the actual investing -- it's finding the investment opportunities. Right now Net Net Hunter members have access to over 450 net net stocks in 5 countries, as well as Shortlists of the best possible net net stock opportunities in each country. Make the most of your time by quickly finding the best net net stocks available.

http://www.netnethunter.com/joel-greenblatt-original-magic-formula/