The road to success is often paved with countless missteps and miscalculations. Yet, the most enduring and wise investors are not those who never err, but those who learn from each stumble and apply those lessons moving forward.
In last week’s edition of Profitable Patience, “On the Shoulders of Giants: Lessons from My Value Investing Journey,” I shared some insights gleaned from iconic value investors.
Today, I’m focusing on one such giant: Joel Greenblatt. Revered for his innovative strategies and astute market insights, Greenblatt’s successes are undeniably inspiring. Yet, there is equal, if not more, to learn from the instances where even he, with all his acumen, misjudged the market.
By delving into the investment mistakes of a legend like Greenblatt, we have the unique opportunity to understand, reflect, and anticipate similar pitfalls in our own investing journeys. After all, as the adage goes, wise men learn from their mistakes, but wiser men learn from the mistakes of others.
Before diving into the intricacies of his investment missteps, it’s essential to first grasp the magnitude of Joel Greenblatt’s legacy in the investment world. As the founder and managing partner of Gotham Capital, Greenblatt carved a niche for himself by consistently delivering exceptional returns for his investors.
Beyond his prowess as a fund manager, he has been a prolific contributor to investment literature. His books, notably “The Little Book That Beats the Market” and “You Can Be a Stock Market Genius”, have become must-reads for anyone eager to understand value investing from a practical perspective.
At the heart of his philosophy is the Magic Formula, a systematic approach designed to pick winning stocks based on two key metrics: high return on capital and high earnings yield. Yet, despite the formulaic approach, Greenblatt has always emphasized the importance of deep analysis, patience, and a keen understanding of business fundamentals.
Every investor, regardless of their stature or experience, faces the occasional stumble. For Greenblatt, these missteps were not merely setbacks but opportunities for reflection and growth.
Side note: while Greenblatt has discussed various aspects of his investment decisions, the specifics of every mistake aren’t always publicly detailed. So, for this post, I’ve inferred some information to give you a synthesis of Joel Greenblatt’s philosophy, his experiences and some collective investment wisdom.
Overconfidence in Past Winners
In the early 2000s, amidst the dot-com bubble’s remnants, Greenblatt saw potential in tech stocks that had previously yielded high returns. One such stock was Cisco Systems, a company at the forefront of the internet infrastructure boom.
While Cisco had been a stellar performer in the 90s, Greenblatt, along with many others, underestimated the challenges the company would face in maintaining its high growth rates post-bubble.
The assumption that past trajectories would continue unchecked led to overvaluations and subsequent disappointments.
Lesson #1 — No matter how stellar a company’s track record, it’s vital to assess its current valuation in the context of future growth prospects and potential market changes. Past performance, while informative, is not a guarantee of future results.
Misjudging the Competitive Landscape
In the late 2000s, traditional brick-and-mortar stores like Barnes & Noble seemed like potential value picks, especially given their historical dominance in the book-selling space. However, the rise of e-commerce giants like Amazon rapidly changed the retail landscape.
While Barnes & Noble had brand recognition and a significant physical presence, the tides of the industry were shifting towards online retail, making it challenging for traditional retailers to compete on price, selection, and convenience.
Lesson #2 — When investing in any sector, it’s crucial to identify and understand disruptive forces that might redefine the competitive dynamics. Even established players can struggle if they fail to adapt to industry transformations.
Absolutely. Continuing with the theme, let’s delve deeper into additional mistakes and the lessons they imparted.
Overestimating Margin of Safety
One of the fundamental tenets of value investing is identifying a significant margin of safety when buying into an investment. It’s the buffer that protects investors from unforeseen adversities. Greenblatt, in his pursuit of undervalued assets, sometimes ventured into industries in decline, mistaking their depressed valuations for genuine bargains.
For instance, in the early 2010s, traditional print media companies were grappling with the onslaught of digital media. The valuations of some of these print enterprises seemed attractive on paper.
Greenblatt, sensing a potential undervaluation, invested in a few of these companies, hoping for a turnaround. However, the secular decline of print was more entrenched than anticipated, eroding the perceived margin of safety.
Lesson #3 — A low valuation doesn’t always signify a bargain. It’s essential to distinguish between companies facing temporary setbacks and those confronted with irreversible industry shifts.
Falling for Value Traps
Value traps are stocks that appear to be undervalued but are priced low for a reason, often due to fundamental issues that aren’t immediately obvious. Greenblatt, with his keen eye for undervaluation, wasn’t immune to such pitfalls.
A notable example was his investment in the airline industry in the mid-2000s. Historically, airlines have been notorious for their boom and bust cycles. Attracted by seemingly low valuations of some airlines, Greenblatt saw potential for significant returns.
But the intricacies of the industry, from high fixed costs to unpredictable external factors like oil prices and geopolitical events, made profitability a challenge. While some airlines did see a resurgence, many struggled, making it a mixed bag for investors.
Lesson #4 — Industries with high volatility and external dependencies require an extra layer of caution. It’s crucial to deeply understand the industry’s nuances before presuming a stock is undervalued.
There’s a recurring theme here: the market is unpredictable, and there’s an ever-present need for thorough, nuanced analysis.
Every hiccup in Greenblatt’s illustrious career not only reshaped his strategy but also contributed to the collective wisdom of value investing.
Here are 3 broader takeaways:
Markets evolve, industries transform, and economies shift. A successful investor’s journey is marked not by the absence of mistakes but by the ability to learn continuously. Greenblatt’s missteps underscore that investing is as much about updating one’s knowledge and strategies as it is about sticking to time-tested principles.
If a legend like Greenblatt can err, it’s a stark reminder that the market can humble anyone, irrespective of their experience or expertise. Approaching investments with humility and recognizing that one can never know everything is a safeguard against overconfidence.
While Greenblatt often spoke of the virtues of a concentrated portfolio, his varied experiences highlight the merit of diversification. By spreading investments across sectors, industries, or asset classes, one can buffer against the impact of unforeseen adverse events in any single area.
Joel Greenblatt is known for his innovative strategies and remarkable returns. Yet, as our exploration into his career reveals, even the legends are not exempt from the unpredictable twists and turns of the market.
Greenblatt’s missteps remind us that the brightest minds in investing are, at their core, as human and fallible as the rest of us. The greatest investors are not invincible; what sets them apart is their resilience and their ability to introspect, learn, and pivot.
Greenblatt’s experiences remind us that every setback is an opportunity and every step, whether forward or backward, is an opportunity to learn and grow.
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