# THE BIG SECRET FOR THE SMALL INVESTOR – SUMMARY (JOEL GREENBLATT)

## Метаданные

- **Канал:** The Swedish Investor
- **YouTube:** https://www.youtube.com/watch?v=XR57WlqX4iM
- **Источник:** https://ekstraktznaniy.ru/video/21341

## Транскрипт

### Segment 1 (00:00 - 05:00) []

Indeed, most individuals, MBAs and professionals who try to beat the stock market won't. But if you follow the plan laid out in this video, you can. Yes, I know it sounds too good to be true, but there's a lot of statistical evidence that points to this fact, which we'll get to, so hear me out. This is a top 5 takeaway summary of The Big Secret for the Small Investor, written by Joel Greenblatt. And this is The Swedish Investor, bringing you the best tips and tools for reaching financial freedom, through stock market investing. Takeaway number 1: How to beat Warren Buffett? What strategy would you use to beat Michael Jordan? Well, you could just avoid playing him in basketball. This is the kind of advice that Joel Greenblatt gives to his students at Columbia Business School, an Ivy League school where he teaches investing. What does he mean? Let's take another example that might hit closer to home. How do you beat Warren Buffett? You challenge him to a running contest? No, that's just mean. There is a better way. You invest in small stocks. You just pick a league where Warren Buffett can't play. You know, he plays in the Diamond League. He must invest in giant companies like Apple and Nvidia and the likes, but you can choose to dominate in Bronze. The nice thing about investing is that it doesn't matter if you get your over performance from small or large stocks. A 15% return is still a 15% return, no matter where it was achieved. Over time, if you compound for a couple of years, you'll be forced to graduate and move up the ranks. But right now, you have a significant advantage by being small. How small do you need to go? You know when you've got a big idea. The problem for us is that big now really means big. It has to be billions of dollars to move the needle very much at Berkshire. So if you don't want to go head-to-head with Buffett, look at the stocks where he isn't interested anymore. He simply can't put meaningful amounts of money in there. Any company with a market cap lower than 1 billion seems to fall within that category. And that still leaves plenty of opportunity, you know, like 826 companies in Sweden alone. So it's a huge playing field for the smaller investor. It's not just that you'll avoid the big fish by applying this strategy. It's also that you get more opportunities to choose from. And as we shall see, that's really beneficial in and of itself too. Takeaway number 2. The lazy man's approach to valuing stocks. The secret to successful investing is figuring out the value of something and then paying a lot less. The father of value investing and Warren Buffett's mentor, Benjamin Graham, called this investing with a margin of safety. The greater the distance between the price you are paying and the value you are getting, the larger the margin of safety. If you insist on getting a large margin of safety when buying, a lot can go wrong before you are selling and you'll still end up on top. But, how does one value a stock? A difficult but correct way of doing it is by looking at discounted cash flows. A company is worth the money it can pay out to its owners from today until judgment day, after you consider that money today is worth more than money tomorrow. Let me explain. Swedish Sundays is a franchise earning 1 million dollars per year. We know it will continue to do this for 30 more years, and then it will be gone. Don't ask why. So, is Swedish Sundays worth 30 million? 1 million per year times 30 years equals to 30 times 1? Not quite, because 1 million today is worth more than 1 million next year, which the year after that, and so on. How much more? It's got a lot to do with where interest rates are at, but let's say 6% or more. That's Greenblatt's minimum. He will use a higher number if interest rates are higher than that. With a 6% discount rate, Swedish Sundays is worth 14. 1 million dollars. But, it is not that simple. Remember, I told you how much Swedish Sundays would earn over the next 30 years. Are you really going to trust my predictions about a business earnings over 30 whole years?

### Segment 2 (05:00 - 10:00) [5:00]

Remember, I'm just a YouTuber who doesn't even know that Benjamin Franklin has never been a US president. Actually, forget about 30 years. In the real world, most analysts have a hard time predicting a business earnings during the next quarter. The good thing is that, as everyone finds this exercise difficult, it becomes like a test in college where you are graded based on your percentile. Getting 55% right might get you an A. And earn you a shitload of money. And because no one can do this 30-year thing with any accuracy, Greenblatt suggests we scrap it and do something easier with opportunity costs instead. It works something like this. How much does Jupiter weigh? I don't know, and I'm not sure that anyone knows exactly. But does it weigh more than Pluto? That's easier. How many times can Captain America get hit and still get up? 1 2 3 I just don't know. It's a difficult question. But can he take more punishment than, say, Loki? Similarly, it might not be easy to say exactly how much a specific company is worth, but it's easier to say if one is relatively more attractive than another. First, we must make sure that it beats the before-mentioned 6% or the 10-year treasury yield. If the stock we're looking at can't even beat the US treasury, which is seen as pretty much a risk-free investment, then why should we bother with it? Currently, the 10-year treasury is 4. 3%, so we'll use 6% as our opportunity cost. Let's see if, say, Apple can beat that. It's been growing 7% per year over the past 10 years, and 8% over the last 5. It's earning something like $100 billion per year, which is pretty much all cash, so that's a yield of approximately 3% on current valuations. Apple must grow like this for another 10 years or so before reaching the 6% yield we are looking for, which, in my world at least, is not a given. So, at current valuations, I'd say that Apple doesn't pass the first test. If it had been around PE20 or below, like it was a couple of years ago, I would have given it a pass. Secondly, we compare all stocks that pass the first test to each other. Greenblatt has two metrics he is especially interested in, which we'll get to soon. Takeaway number 3. Index investing is flawed. And we can do better. You've probably heard that it's challenging to beat the market. And it isn't easy to find managers who beat the market either. So, the odds are you'll do better by just buying the index. But, market cap-weighted index funds are fundamentally flawed. Look at this graph. When was the best time to buy Disney during the last 3 years? Yep, that's right, when it was the cheapest. When was the worst time? Yep, when it was the most expensive. What do you think the index funds did? They bought more Disney when it was expensive and less when it was cheap. Think about it like this. If Disney was x% of some index when it was cheap, it might have been 1. 5x% when it was expensive. When new money reaches the index fund, it bought 50% more Disney at the peak than at the bottom, as a portion of the whole. Suppose you don't believe in the efficient market theory. In that case, you've accepted that the bipolar Mr. Market sometimes gets too optimistic and sometimes too pessimistic. One example when he was overly optimistic about IT companies was during the dot-com bubble. And what did an index fund do during that time? IT made up a much bigger part of index funds' portfolios than both before and after the bubble. One example of when Mr. Market was overly pessimistic arrived shortly after, right after the horrible 9-11 attacks. Mr. Market wouldn't touch airline stocks with a 10-foot pole. And index funds shied away from them. But that, too, was a mistake.

### Segment 3 (10:00 - 15:00) [10:00]

We don't even need to know which stocks that are overpriced and which ones that are underpriced, we just need to know that some stocks are mispriced relative to their fair value. It follows that index funds will buy too much of the overpriced ones and too little of the bargains. A straightforward solution to this problem is to equal weigh our portfolio. This way, sure, we'll accidentally buy some of the overpriced stocks at times, but at least these errors aren't systematic. Another way is to use weights based on fundamentals, such as book value, sales, earnings or cash flows. There are funds out there with quite low fee structures that can do this for us, by the way. One study called Myths about Fundamental Indexing from 2018 shows that such other forms of indexing overperforms traditional market cap-weighing by some 2. 7-4. 5% per year. This study was conducted on 3,300 stocks over 25 years. However, Greenblatt thinks we can do one better. By the way, if you are interested in joining me on my stock market journey, a journey that has returned 16. 8% per year over almost 12 years, head over to my Patreon. There's full transparency of what's in the portfolio, and you'll get deep dives on every portfolio company, explaining how I think about individual stocks. Takeaway number 4 – Create your own value index. Remember that I said earlier that valuing a stock is tough and that choosing between two alternatives is typically easier? You've probably heard Warren Buffett say that. Well, both Buffett and Greenblatt obviously prefer to get it both cheap and wonderful. How does one determine if a stock is cheap? There are plenty of alternatives, but one of the simplest ones is to compare how much it costs to how much it earns. That's the company's P. E. Apple currently has a P. E. of 33, and Google 18. Google is cheaper. Simple. But what does Buffett mean by a wonderful business? This one requires a little bit more accounting knowledge to understand, and I won't go into the details right now. I'll just leave two common alternative ways of measuring this on the screen for you to check later if you are interested. The main point is this. We can rank stocks based on both how cheap they are and how good they are and then buy the ones with the best combined ranking. In this way, we'll create our own value index. By the way, this is a version of Joel Greenblatt's magic formula, and if you want a how-to on this ranking system, have a look at my summary of his book, The Little Book That Beats the Market. Greenblatt back-tested this during 1990-2010. It made 13. 9% per year compounded versus 7. 9% for the Russell 1000 and 7. 6% for the S&P 500. That's a big overperformance. If you'd start with $10,000, you'd end up with $135,000 in the value index and only about $45,800 and $43,300 in the Russell and the S&P. So, market-cap-weighted indexes beat most active managers. Equal-weighted indexes and fundamentally-weighted ones beat market-cap-weighted ones. But value-weighted indexes beat them all. Takeaway number 5. Tie yourself to the mast. This is the voice of the experienced, and in the stock market, it's advice that we should heed. Entire books have been written on behavior finance, concluding that we are hardwired to be lousy investors. We fear loss much more than we enjoy gains. When living on the savannas in Africa, it was reasonable to run from the lion and ask

### Segment 4 (15:00 - 18:00) [15:00]

questions later, but when we do this in the stock market, we're just another lemming on the way towards slaughter. And for professional investors, it is even worse. Looking at the top 25% performing managers during the first decade of the 2000s, almost half of them spent at least one three-year period in the bottom 10%. Could you hold on during such downswings? Most people can't. So it's even worse for professional investors because even if they can manage to keep a long-term vision, most of their clients can't. Without clients, you have no business. This is becoming a bigger problem for money managers because the rise of technology has made it so easy for clients to monitor returns, even on a daily basis. When clients get more and more short-sighted, they will make money managers more and more short-sighted. And when everyone is more short-sighted, the payoff for taking the long-term view is even greater. So, what does Joel Greenblatt suggest that we small investors should do to combat our flawed investing genetics? Here's the plan. Let's develop a strategy that can help us avoid making our mistakes. At the same time, let's assume that others will keep making their share. We should tie ourselves to the mast beforehand like Odysseus did when facing the Sirens. For starters, we don't fiddle with this value index every day. You make one rebalancing per year, and that's it. Set aside a full day, and then do not log into your brokerage account more than once per month or so. You'll still want to have your broker alert you in the case of a corporate event though, you don't want to miss out on a buyout or something. Secondly, Greenblatt suggests putting 40-80% of one's money in stocks. Decide on a number beforehand, say 80%. Now, you can change this number to 70% or 90%, up or down a maximum of 10%, but only once yearly. This way, we give ourselves some wiggle room, because we are no machines. However, we still get most of the benefits from investing in a valuated index. And here's the big secret. If we follow this plan, small investors like us will have a huge advantage over professionals, an advantage that has only been growing larger every year. So, beat the professionals by investing in smaller stocks. Use opportunity cost when deciding on which stocks to pick. Index investing is flawed, because it systematically buys too much overvalued stuff and too little undervalued stuff. You can create your very own value index by buying companies that have a low PE and a high return on capital. The secret for the small investor is that we can keep a long-term horizon in a world that is gradually losing its attention span. Joel Greenblatt likes to joke that the big secret will remain a secret, since pretty much no one bought the damn book. Greenblatt's other book, The Little Book That Beats the Market, has more than 10 times as many reviews on Amazon. Is it also 10 times as good advice? Check out my video summary on it and decide for yourself. Cheers!