The transcript from this week’s, MiB: Joel Greenblatt on Relative Value, is below.
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VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: This week on the podcast I have an extra special guest, the return of Joel Greenblatt. Joel is a former hedge fund manager. He started Gotham Capital in 1985 and put up just insane numbers, 50 percent a year after all expenses for something like seven, eight, nine years. In 1995, Gotham was closed to outside investors. It has essentially became a family office, and he ran that through 2009. He was one of the early investors in Michael Burry’s hedge funds. Michael Burry made famous by both the book and the movie, “The Big Short.”
And he is now running Gotham Asset Management, which has put together a number of really interesting mutual funds, including a sort of value-weighted S&P 500 index that has beat the index for a couple of years running. It is not a traditional price to book sort of value-based tilt. It’s all about future cash flows, and moats, and relative growth and value. Really the best way to think of it is a relative value tilts to the index. It’s done really well.
I always find Joel to be a fascinating guy. He understands the world of value investing better than most. His track record is simply outstanding, and he really has nothing to prove and nothing to sell. He’s just a fascinating guy who’s shot the lights out repeatedly.
So with no further ado, my interview with Gotham Asset Management’s Joel Greenblatt.
VOICE-OVER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: My special guest this week is Joel Greenblatt. He is the principal and co-founder, CIO of Gotham Asset Management. He’s been an adjunct professor at Columbia School of Business since 1996. He is the author of numerous best-selling books, including “You Can Be a Stock Market Genius” and “The Little Book That Beats The Market.” His newest book is called “Common Sense: The Investor’s Guide to a Quality Opportunity and Growth.”
Joel Greenblatt, welcome to Bloomberg.
GREENBLATT: Thanks, Barry.
RITHOLTZ: So let’s start a little bit with the book, “Common Sense.” What — first of all, what motivated you working in finance to write a book about opportunity, growth and equality? It seems to be a little different than your traditional value investing or is it?
GREENBLATT: Sure. Well, I’m a capitalist. I’d like to — to work well.
An investor, in general, has a — a certain way of looking at the world. And there are a lot of problems that capitalism has led to or the way at least we implement it. And — and so there are certain things that seemed fairly reasonable to me to suggest of tweaks we can make to the way the system works now to — to make things better for everyone.
And so, you know, most people don’t write this book from the perspective of a long-term investor, and — and so that’s what I did here. And — and I hope it brings another perspective to solve some of these problems, particularly the ones that are very important to people now including inequality and opportunity.
RITHOLTZ: So let’s dive right into issues of opportunity. By page count, almost half the book — maybe even more — is about education. So let’s start — let’s start there. You — you started a not-for-profit charter school in New York City in 2006. Why did you do that? And what did you learn?
GREENBLATT: Well, sure. Well, the reason I did that is if you look at the statistics, if you are black, Hispanic, low-income in one of our major urban centers, maybe the top 50, your odds of graduating college right now were one out of 11.
RITHOLTZ: Wow, (inaudible).
GREENBLATT: We know the college graduates are 70 percent more than high school graduates. High school graduates are 30 percent more than dropouts, but that’s — that’s huge. And it’s not from lack of ability. At least that’s part of the reason that I got involved in a charter school space.
Everyone has choice. If — if you have any kind of money in our system and you don’t like the school in your neighborhood, you can move to a neighborhood with a good school or you can send your kids to a private school. If you don’t have means, you get what you get and you don’t have a choice. And the idea behind charter schools, which just to define them are publicly-funded schools run not by the district, meaning run by independent operators.
And it turns out that the charter schools in states where they have high standards of who gets to open one and who gets to keep running one — or, obviously, if they’re close if they’re not doing well, all those tend to be the states like New York, Massachusetts and California where the charter schools do well. And so the idea was to set-up a — a charter school in New York City, and it’s always OK or it’s been done before to open one school and put a lot of resources into it, make sure that it works well. And the idea behind this one was to do something replicable. And the big hairy audacious goal when we got started was to open up one school, but 40 schools.
My — my business partner John Petrie and I hired a woman, Eva Moskowitz, who was the CEO and founder of the Success Network that I’m involved with. And today we have 46 schools and 20,000 kids. And last year, according to the state test in Math and English, those 20,000 kids in all low-income neighborhoods — minority neighborhoods outperformed every wealthy district in the state, including Scarsdale, Great Neck and all the other top districts in the state. They would be the number one district. …
RITHOLTZ: Wow. What’s the lesson from that? What can we learn from charter schools and bring to public schools that are underperforming?
GREENBLATT: Well, I think the biggest lesson would be that it’s not lack of ability that the kids aren’t successful. The kids can do it. If you have high expectations, the kids can meet them. They just need the right supports.
And charters, of course, have some advantages over the district schools. They get to select their teachers and keep the ones that they think are doing a good job. They could pivot quickly to — to only do what works or to improve things that aren’t working, and they can do that very quickly.
We spent 30 percent more time in school at our charter than the district schools.
RITHOLTZ: Wow.
GREENBLATT: So that’s an advantage. And a big advantage is parents choose to come. And so it’s good to have the support of the parents, and that is an advantage.
RITHOLTZ: In your book “Common Sense,” you highlight PS 172, one of the country’s best public school. It’s run by Jack Spatola. What makes him such a special principal? Why is that public school, not a charter school, why is that succeeding so well versus the average public school in any big city?
GREENBLATT: Right. So the book, as you suggested, is not just about charters, it’s about good schools anywhere, giving good choices, right? The — the — the kids with the lowest family — the families with the lowest means don’t have a choice. So it’s how can we make their district schools better, how can we give them choice of a good — a good school choice.
And they’re certainly good district public schools, one that I highlighted. You suggest Jack — Jack Spatola is the principal — he just retired — for PS 172 in Brooklyn. But to tell you how good — a really good school can be and this is a district school, 99 percent of the kids passed the Math exam and 94 percent passed the English exam. And in most other schools, it’s below 40 percent.
But that’s not the special thing. The special thing is that that 99 percent passing Math and 94 percent passing English, what are the statistics for the students with disabilities at that school?
RITHOLTZ: Wow.
GREENBLATT: So in other words, kids without disabilities did less than half as well in the — in the regular district schools. That tells you how good that school is. The English language learners, 90 percent passed the English exam at his school, PS 172, in the regular district schools with nine percent, so 10 times better.
RITHOLTZ: What can be done with a school, like Spatola’s like PS 172, that can be ported over to regular public schools?
GREENBLATT: Of course, that’s the right question. And if you ask Jack Spatola, the principal, he would say having high expectations for every child. Just keep looking if something doesn’t work for students, find something else. If that doesn’t work, find something else and keep working, but it’s high expectations, expecting that each child, including students with disabilities, including language learners can do the job with the right supports.
So he would say that. But I would say that only one principal can be the best principal in the state. It’s probably Jack.
It’s very hard to — it would be wonderful if the average principal could be this good. And — and we strive to get there, but it hasn’t happened.
And I just point out that good charter schools, you know, with — you know that where kids — poor and minority kids outperform the wealthiest districts, and a school like Jack’s where even the kids with disabilities are crushing it point out that the kids can do it. So the 10 out of 11 who are not graduating college, it’s the — not from lack of ability. And so the question I posed in the book is what can we do for them they can do the job, they can do the job. And so that’s what I used them for.
It’s a big, big question you’re asking how do we move this, you know, Jack’s success across the districts. And — and one of the sad answers is that not everyone can be Jack Spatola. But, of course, he should be studied, and so a real question should be why isn’t what he’s done, studied even more, and it — and it’s not. So that’s a little sad.
But right now, it doesn’t look like those 10 out of 11 are being serviced. What can we do about that is what I read about in the book.
RITHOLTZ: Let’s talk about one of the solutions you write about, alternative credentials. What are they and how would they work for — for students coming from these disadvantaged neighborhoods in schools?
GREENBLATT: Yeah. So I — I call it alternative certification. So I point out the — the 10 out of 11 that the current system isn’t working for. And I — and I write in the book — you know, I want to pose this question when Tiger Woods was at the top of his game to my students at Columbia. I said, “You know, how do you beat Tiger Woods?” And my answer was, “Don’t play him in golf.” And the idea that I suggested in the book is something I called alternative certification.
And so I’ll give you an example. Let’s say you want to work in the H.R. Department at Microsoft. What I’m suggesting is Microsoft should simply specify which tests, courses or certificates in lieu of a college degree that they would consider when judging applicants for high-paying job in that particular department? So these — these things could include a simple literacy test, an online course, a certificate program or even a game-based test, and the list together with McKinsey has created game-based test that measure decision-making and critical thinking skills. So it doesn’t have to be a standard test. There’s a lot of different ways you can test for talent.
And so what I suggest in the book is that leading companies like Google, Microsoft, Amazon, J.P. Morgan, they wouldn’t have to create these tests or courses or administer them. What they would do is merely make public a list of which tests, which courses, which certificates would be considered in lieu of a college degree when selecting candidates for specific jobs, (inaudible) for passing these things.
RITHOLTZ: What’s the response?
GREENBLATT: That’s when the whole ecosystem would develop, sorry. Go ahead.
RITHOLTZ: Well, I was going to ask, what’s the response been like from corporate America?
GREENBLATT: Well, you know, the book just came out, so I’m very hopeful. And one of the reasons I’m talking on your show, Barry, is to get this idea out there. It’s already starting in some ways, but the idea behind it is once there’s a buyer, in other words, all these big companies have to do is make the list public. What we will consider in lieu of a college degree and then a whole ecosystem, hopefully, will develop the supporting online resources and tutoring services were developed to help applicants pass these tests and courses and meet the new demand from these top companies. Great thing about this is none of it would require government involvement, and the cost would be much, much lower than the current systems.
Now you might ask …
RITHOLTZ: Sounds …
GREENBLATT: … what do you do for students with disadvantaged backgrounds from disadvantaged backgrounds. And I would assume they were also developed as long as there was this demand at the end of the day for passing these courses is that there would also be prerequisite courses that would develop as well, whether online or in-person teaching and supporting resources that would all be rated like Uber drivers and Airbnb rentals.
Once again, none of it would require government involvement. They would be setting standards. They wouldn’t need government funding.
Now, this is already starting. Google has already created six-month certificate courses in a few technical areas, which, if you pass, they’ll consider you for a job. But I’m suggesting something much simpler where companies just set standards of which existing tests or new test that they would look at or courses or certificates that you could receive that they’ll consider. So I think it would really jumpstart this whole sort of runaround. You know, in other words, don’t play him in golf, run around the current system because it’s just so unfair. This is what the 10 out of 11 could try to pursue without any government assistance.
It’s not ideal. It’s not first choice. Of course, we want great schools and we could just keep working at it, but this is something these major corporations can do right now — set these standards and then hopefully this whole ecosystem will get going.
RITHOLTZ: Quite fascinating. Let’s talk a little bit about too big to fail banks. You wrote, quote, “Banks are almost wired to get into trouble,” unquote. Explain.
GREENBLATT: Well, it’s pretty straightforward. You know, money is fungible, so who pays the most? The depositors. Who lends money to borrowers the cheapest and with the easiest terms is who wins. The industry is competitive and it’s very leveraged. So pretty straightforward why banks are wired to get into trouble.
So what can we do to make these banks no longer too big to fail? How do we make them safer for both taxpayers and investors?
RITHOLTZ: Well, you know, in 2008, after the 2008 banking crisis, there are plenty of regulations including Dodd-Frank and made the whole system a lot safer than it was. But more regulations have very high costs. There’s a lot of repercussions from a lot of regulations (inaudible). You know, mostly only big banks can handle them. Smaller banks are dropping and closing like flies, and almost no new small bank charters are being applied for because small banks can’t afford all these regulations.
Also under the system, banks are penalized for making small business loans. It hits them from the new risk factor, so corporate bank loans under a million dollars dropped by 75 percent since 2008. And we know what’s happened to new business formation. It’s way, way down.
The other problem is we also have itself too big to fail. The Minneapolis Feds still — came out with a study saying that it’s still two out of three chance that we’ll need another government bailout in the next century. And so we are hurting small businesses and small banks, and we have itself too big to fail with all these regulations. So I write in the book about — I tell a story about in the — the late 18th century, early 19th century, the English used to ship their prisoners to Australia. And in one of the earliest trips about 40 percent of the prisoners died along the way, which was horrific.
And so how would you solve a problem like that? Well, obviously, you could solve it with more regulations covering the medical care for the prisoners, and food on board, and safety and cleanliness, and put more government monitors onboard. There’s a lot of things you could do to try to solve that problem.
The other thing you could do is to change the incentives from the beginning and say to the ship captains, “We’ll pay you for the prisoners if they get to Australia alive and well, and we’ll penalize you for those who don’t,” right? So it’s setting incentives up from the beginning rather than micromanaging all the regulation.
And so I suggest sort of the same thing with banks. You know, when a restaurant fails, the economy doesn’t skip a beat. It’s not true with banks. The financial system is too big, it’s too intertwined. And — and we need to do something.
Right now we’re really the backstop, meaning we do have to bailout the banks if — if things turn bad, especially the biggest ones. And so one of the clear answers would be if, you know, there’s less than 10 percent equity cushion in the banks, there have been a lot of things in Dodd-Frank that, you know, go to risk control, types of equity, things of that nature.
But I just suggest in the book that if we brought — if we set the incentives up correctly upfront so that you had 20 to 30 percent equity, what I suggest is a new type of preferred, not — not common equity. But to increase by 10 percent common equity to 20 or 30 percent using a new type of preferential preferred, where the preferred is deductible for the bank, it’s tax-free for the holder. So obviously it’s helping the banks.
But when things go bad for the banks, if you don’t have 30 percent equity, anything that goes bad is the bank’s problem. It’s like the restaurant failing.
RITHOLTZ: Right.
GREENBLATT: No one really CARES. It’s an equity holder, and I suggest the incentives are set-up that both the board and management are incented by the combined value of the equity and the preferred as if they’re stapled together as one security. So we set the incentives up correctly. You’d still have a leveraged returned from the common equity portion. But if there’s any problems, it would be covered by the preferred holders.
It sounds like we’re giving a bonus to the banks to make this deductible for the banks and to make it tax-free, but actually we — we won’t have too big to fail anymore. We’ll have plenty of equity and they’ll cover their own. The — the losses will fall where they should. The incentives will be aligned correctly from the beginning. It’s — it’s a pretty simple solution to a difficult problem.
RITHOLTZ: Right. That would require a little bit of legislation to both create that class of preferred, make it deductible to the bank and make it tax-free to the investors is — and essentially, you’re asking the investing public to step in in place of the taxpayer to make sure banks have a big enough capital cushion.
GREENBLATT: Right. We’re already supporting banks for a good reason, right? We already support them so that depositors don’t lose their money and we don’t have (inaudible) depression. So this is more upfront way of doing it.
If we’re just a backstop that’s going to have to backstop in a crisis, we’re there but it’s kind of hidden. Here …
RITHOLTZ: Right.
GREENBLATT: … we take care of it upfront. Yes, we’re giving a benefit to the preferred, but we’re very upfront about it. And we then align the incentives exactly how they should be, that shareholders whether the preferred or common will take all the losses, not the government.
RITHOLTZ: And this solves too big to fail because even if there’s a major crisis and banks lose 15, 20, 25 percent of their capital it doesn’t wipe them out.
If I remember in the book, banks currently are running seven, eight, nine percent of capital reserve. Is that about right?
GREENBLATT: They are. And I go — I go through the math. I mean, you know, with all the different risk controls and — and then there is subordinated debt that turns into equity now, but I argue in the book that we’re not going to really pull that lever. We’re not going to force some big bank to convert its subordinated debt into equity even though that’s one of the options we now have. And — and that’s because, you know, it’ll cost a crisis of its own. It’ll cause a cascade. And that’s what Neel Kashkari argues, too, at the Minneapolis Fed. And — and I agree with that.
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RITHOLTZ: So if we make this new type of preferred available, it becomes strictly voluntary for the banks to do it or are they obligated to change our capital structure to have 15, 20, 30 percent capital and reserve with this new type of preferred share class?
GREENBLATT: Right. So if they want to be free of certain regulations that are protective otherwise, they can issue this preferred and — and therefore take the risk themselves. Otherwise, they’d be subject to a lot of restrictions on the type of loans they can make and things of that nature so — which is stuff we’re already doing.
RITHOLTZ: Quite fascinating. Let’s talk a little bit about what’s going on with young people today investing. What do you think of the rise of Robin Hood investors? Is this a good thing or is this just bored millennials at home without access to sports or socializing?
GREENBLATT: Barry, I don’t think it’s a great thing. I think it is good to be exposed to investing for most people and to be thinking about saving for retirement. But I — you know, when we saw on the Internet bubble, you know — you know e-trade and the other discount brokers, most of those people lost a lot of money. I — I think you’re speculating without knowing what you’re doing is not a great idea.
And so, you know, I wrote a book called “The Big Secret,” and I think you’ve heard me say it’s still big secret because no one thought that particular book, but talked about the best performing mutual fund. I wrote in 2011 for the decade 2000 to 2010, and that fund was up 18 percent a year when — during a decade where the market was flat. Yet the average investor in that fund managed to lose 11 percent by moving in and out at all the wrong time.
RITHOLTZ: Right.
GREENBLATT: And that’s because people are emotional. If you don’t really understand what you’re investing in, you pile in when things are going well. You pile out when they’re not going well. When something’s working, you put more in. When it’s not working, you put less in. And you make all the wrong moves. And I think when things turn around for these investors, it’ll end up not great.
RITHOLTZ: So you’ve been teaching for a long time, not only lecturing MBA students at Columbia, but you also teach a bunch of ninth graders at a high school in Harlem. What’s the difference between those two students and what are you trying communicate to each group?
GREENBLATT: Sure. Well, it’s interesting question. You know, I — I — I taught a couple of years the ninth graders for a semester. And I tried to, at a very early age, explain to them the concept of compounding. And I actually put on the front of their little notebooks a compound interest example, where if you start saving at age 19 and you put in $2,000 a year, and you do that for seven years, and you’re on 10 percent on your money. And then you never put in another nickel, you just do it for seven years starting at 19.
The other example, if you started age 26 and saved $2,000 a year invested at 10 percent and save for 40 years, meaning putting $2,000 a year starting at age 26 for 40 years, the — this these person who started investing at 19 and only putting seven payments of $2,000 ends up earning more money just with seven payments by the time they’re 65 than the person who started seven years later at age 26 and put in 40 payments. So it just talks about how starting to save and invest early is very important. And so teaching in ninth grade it’s important for students to understand that concept.
My average MBA student is already 27 so, of course, they had a lot going for them and so I’m not too worried about them. But it is a huge advantage to start early. And I — I — I made that very clear to both sets of students.
RITHOLTZ: That’s an astonishing data point that a seven-year head start beats investing annually for the same amount for 30 years. What do you think of ideas that have been floated by people? The governor of New Jersey floated the idea of baby bonds that we gift every person born in the United States a $5,000 in an account that they can’t touch until they’re either 25 or — or for college. What are your thoughts on — on something like that?
GREENBLATT: Well, I do like that idea. I think it takes advantage of compounding. I don’t think it’s nearly enough. I mean, the statistics retirement savings for most people are — are pretty horrific. Nearly half of working age families don’t have any retirement savings. The median family between ages 32 and 61 have about $5,000 in retirement savings. The average working age, low-income, black, Hispanic or non-college graduates have no retirement savings.
And here’s a terrible statistic. Nine in 10 families in the top fifth of the income chain have retirement savings. Nine of 10 at the bottom fifth do not. So we need to do something.
RITHOLTZ: That’s amazing.
GREENBLATT: And if you earn between $7 to $13 a year or you earn — I mean, an hour or $10 or $12 an hour, which is about 40 percent of hourly workers do, but Social Security gets you about $9,000 a year. So you need retirement savings. It’s a real, real problem. And we don’t have a system that really takes care of that.
So, you know, what I suggest in the book is that compound interest is something that we can take advantage of and we don’t. We’re kind of blowing it as a country. And so right now Social Security is really based on what you put in as sort of related to what you get out. And so what I suggest is really putting into Social Security, gets capped at $137,000 a year. So I don’t suggest raising taxes, but I do suggest that high earners keep contributing to their retirement above 137,000. They get to keep 80 percent of it, and then you get the tax benefits of saving that so it goes into like a 401(k) account.
But the remaining 15 or 20 percent that they don’t get to keep it, it gets taken off the top now gets put into the account – the accounts of low earners and people just started working so they can take advantage of this compounded interest at an early age. They don’t have any savings outside of Social Security.
And so I suggest a 401(k)-type account for everyone funded by the higher earners, yet the higher earners really are getting the tax benefit of being able to put 80 percent of their amount they put in above 137 into their own tax advantaged saving. So it’s not really raising taxes, it’s giving them an advantage, but it’s also helping out those who need it the most.
RITHOLTZ: So let me make sure I understand this because this is kind of complicated, but it’s really very intriguing. Right now, your FICA contribution, your Social Security contributions top-out at about 137 a year. That number creeps up a tiny little bit each year adjusted for inflation. But effectively, if you are Jeff Bezos or Elon Musk, you top-out on January 1st. You’re done paying FICA for the year.
What — what you’re suggesting is everything above 137 or some percentage above 137, you get to put into a 401(k)-like funds over and above what your current limitations are. Eighty percent of what you move in goes in as if it’s a pre-tax investment, so when you take it out on the other end you’re not paying taxes. And 20 percent of it gets moved into a fund that gets put into individual investors, a similar 401(k)-like fund that they manage and — and you start doing this for — pick a year — 25-year-olds and younger. So in other words, you’re planning about something to fix the looming retirement crisis for 25-year-olds. Is that a fair assessment?
GREENBLATT: Yeah, so it could start earlier than — whenever you start working and start paying in, you get a big supplement. Everyone gets a 401(k) account, which I think everyone should have to take advantage of compounding. So it would go to both young people and low earners. It will go to both.
RITHOLTZ: That’s quite fascinating. Let’s talk a little bit about something that hasn’t gotten much press lately, and that’s what we do with immigrants in the United States. What advantages does the country get from a broader and more open immigration policy?
GREENBLATT: That’s a great question. And — and, of course, immigration is a controversial topic. But there’s one area that’s very clear, and we’re completely blowing that, and it’s skilled immigration. According to the business roundtable, we come in embarrassingly second to last among developed countries welcoming skilled immigrants. The only country we’re better at — at admitting skilled immigrants is Japan, and Japan literally discourages immigration. And not only that, you have to speak Japanese pretty much.
You know, the United States has a huge advantage. You know, English is the universal language of business and science. Second to last is a really bad spot for us for skilled immigration. What’s the big deal about that?
Well, you know, I disclosed in “Common Sense,” the book, that skilled immigrants are actually a natural resource. We make — if you want to put it that way — half a million to a million dollars of fund — each one of them in today’s dollars for everyone we take in. And with that is the math of — of those immigrants and their kids that’s today’s dollars of how much they contribute versus how much they get back from the government. So we make half a million to a million dollars for each skilled immigrant we take in.
We also get close to two jobs for people already here. So for every skilled immigrant we take in, they create two jobs for people already here. So we not only get a pile of money, we also get two jobs. It’s a — it’s a free gold mine. And I’ll tell you why we should be encouraging it.
Immigrants have founded 51 percent of U.S. startups over a billion dollars.
RITHOLTZ: Amazing.
GREENBLATT: They were twice as likely to start a business as natives as natives are. They’re responsible for a quarter of the productivity growth over the last 20 years. And immigrants or their children have founded 216 of the Fortune 500 companies, which is pretty amazing.
RITHOLTZ: There was a data point in the book that I found astonishing. Microsoft had done an internal study. And for each H-1B1 visa immigrant that they bring to the U.S. to work for them internally at Microsoft, they recreate four additional jobs. How on earth is that possible? That — that just sounds astonishing.
GREENBLATT: Well, you know, if you can get the best and brightest from around the world and — and hire someone like that, they need support and — and they create value. And so that was a quote from Bill Gates that they did a study that — at Microsoft. I said across the country it’s two jobs for every one we take in. And Microsoft, I guess, it’s such a high level that they’re taking in, they create four jobs. So it’s pretty, pretty exciting.
The only problem is we don’t encourage them to come. I said we came in second to last. Our H-1B1 program, which allowed skilled immigrants to come in is — is broken. It’s difficult. It takes a long time. It’s expensive. It’s very uncertain whether someone can stay. It’s very limited.
We exceed our cap within about five — three times our capital fly within the first five days of eligibility every year. So …
RITHOLTZ: Wow.
GREENBLATT: … we’re discouraging them from coming in and we should encourage them.
Countries like Canada and Australia take anyone who will come who meet the government standards of skilled — you know, education and skill. And we don’t. We actually actively discourage them. And we actually have a better system than they do in some ways.
RITHOLTZ: There was an — there was a article in Wired over the summer that discusses how Toronto has been feasting on tech workers that were frustrated with the U.S. H-1B visa programs and green card programs and general immigration programs. Are we letting some of our most value-creating and productive tech workers escape from America when we should really be much more welcoming and giving them a path to citizenship here?
GREENBLATT: Yeah, I think that’s pretty clear. You know, I talked about all the money we would yield. I called it a free gold mine. It’s crazy. We’re — we’re throwing it away. I talked about all the money and the jobs we create by taking them in. But we actually have a system that should work even better than Canada and Australia. In Canada and Australia, they set government standards of who they’ll let in, you know, what — what kind of skilled labor. But that doesn’t mean they’re a good fit for a particular open job or that these people are ambitious. They just are people who meet government standards.
The way we work it with the H-1B is that there is an employer who actually wants to give you a job, so it’s very direct. In other words, it’s a one-to-one perfect match. And so I — I suggest that we use that system, that if an employer is willing to pay someone $60,000 or $70,000 a year, we can take as many of those as we want as long as that employer is willing to pay a 20 percent tax on top of that salary — in addition to that salary to the government.
You can take anyone you want. It ends up being cheaper than the current H-1B program. That’s very long. It’s much more certain. If you paid 20 percent tax for five years, you become eligible for a green card.
You know, it’s just unbelievable. I mean, countries that lack opportunity and political freedom and safety, things we have in space, they have what’s called a “brain drain.” And we should be a brain magnet. We have liberty, we have freedom, we have safety, we have opportunity. So, you know, the studies have shown that if — if you survey immigrants, we’re first choice. Second place is Germany and — and we beat them four to one. So we should take every right person, take all that money, take all those jobs that these skilled immigrants bring in.
I think it gets controversial because, you know, we have the Statue of Liberty. So very important (inaudible), you’re poor, you know, what about those seeking refuge or a better life? So I’m not addressing that with skilled immigrants.
But what I can say is this, we’re going to make so many money — so much money from taking, you know, a better skilled immigrant program that we can actually afford to take in for each skilled immigrant — one or two skilled immigrants, we can take eight or 10 unskilled immigrants, you know, and afford to take them in or we can bring in eight or 10 of kids who are already here out of childhood poverty. So we can do either one of those things.
I don’t want to get into an argument, which is a better thing to do, bring in more skilled immigrants to give refuge to people who want a better life here in our country. It’s been very important to our country and I think that’s important or to help the people already here. I don’t want to get into the argument what we should do with all the free money that we get by bringing skilled immigrants. All I argued is we should take the free money.
RITHOLTZ: What do you do with the 20 percent surcharge over hiring? What — where does that pool of capital go? Does that help the unskilled immigrants? Does that help? Any time there’s a big pile of cash, people get their eyes on it. What do you do with that money?
GREENBLATT: Yeah. Well, I would — I would put it into job training for the people already here. I — I would help, you know, employee is already here. Obviously, with the 20 percent premium that you’ll have to pay for a skilled immigrant, you would hire someone anybody who’s here so that you don’t have to pay the 20 percent extra. So you’re really taking in people that you can’t get here already.
But there are people who need more training here. That’s been a big problem. As we know, education is the answer. Job training is the answer to people who aren’t earning enough here. And we can take that 20 percent and put it to very good use in that area. That’s what I would suggest.
RITHOLTZ: How do you deal with some of the structural racism that’s built institutionally into United States that that Wired article I mentioned made reference to a number of programmers and other tech people who are people of color, and this was in both the Virginia part of the country outside of D.C. and outside of San Francisco. They felt that they were harassed by police because they look different even though both areas are filled with immigrants working in tech. And when the opportunity came to go to Toronto, they — they jumped on it. How big an issue is this?
GREENBLATT: Right. Well, in Toronto they — they had the chance for citizenship that they — they didn’t have here under our current system, so that’s part of it. And this has been a problem across the world. You know, it’s happening in Europe where people who look a little different aren’t very well-absorbed into the local economies.
We are the — still the biggest melting pot in the world. So with all our problems, we still have it better than everyone else. And we can provide that opportunity to immigrants here. They still want to come here. It’s still — we’re still the preference.
Second place, only a quarter of the people want to go to. There’s 147 million skilled immigrants who want to come here. So yes, there are problems. I think we have less than many other countries, particularly in Europe. And I think we’re a bigger melting pot than any other country in the world. So I — I — I acknowledge the issues. I’m not going to argue with them. I’m saying we’re — in comparison, we’re still in pretty good shape. We’re — we’re still welcoming, in general.
RITHOLTZ: Let’s pivot to your bread and butter — value investing. You famously gave away the magic formula, which has a wonderful long-term track record. But as we’ve seen over the past five years, value investing has struggled. What’s going on in in value land?
GREENBLATT: Well, you know, I gave a speech, you know, in the last year called this “value investing debt.”
RITHOLTZ: And?
GREENBLATT: And my answer was yes, no, maybe and I don’t care.
(LAUGHTER)
And the reason for that is it really depends on how you define value. If you define it like Russell or Morningstar where it’s low price book, low price sales investing, it’s had a tough time, an — an extraordinary time.
Last five years, growth — the way they define it at Morningstar or Russell — has outperformed value by 11 percent per year. Last three years, it’s 17 percent per year growth outperforming value. The last 12 months, it’s about 43 percent. These are phenomenal numbers. These are numbers bigger than during the five years before the top of the Internet bubble. These are slightly bigger, slightly bigger to discrepancy between growth and value.
So your question is — is very good. If you define value like we do, which is figure out what a business is worth and pay a lot less, that’s what I define as value investing. And, you know, Ben Graham would say leave a large margin of safety, then that’s never really going to go out of style. We — we look at companies like we’re a private equity firm. No private equity firm buys a business because it’s a low price book or little price sales. They’re really looking at cash flows.
RITHOLTZ: Right.
GREENBLATT: OK. So while in a period like this where anything that’s somewhat out of favor, even though it’s not low price book, low price sales, they rhyme together. And if people are willing to pay growth at any price, then that’s not going to be a good period for any style of value investing.
But if — and the question is is value investing dead or is it going to continue, it comes down to how you define it. And people will always come back to valuation. It’s based on cash flows and how much those cash flows are going to grow over time. As Buffett would always say, growth and value were tied at the hip. They’re part of the same equation, figuring out value. So once again, we’re talking about definitions.
RITHOLTZ: So one of the interesting …
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RITHOLTZ: I don’t want to call it post mortems, but analyses on why growth has been doing so well relative to value over the past 10 years, is that in an era of low inflation and very low rates? Capital intensive industries like tech and growth, it’s a very inexpensive input to them versus high inflation or higher rate regimes. Value is presented an opportunity to shine because it apparently needs less capital. What — what are your thoughts on those sort of analyses of — of value versus growth these days?
GREENBLATT: Right. Well, that’s a great question. And so if you’re talking about low price book investing, of course, it’s — it’s very relevant. If you’re talking about cash flow-oriented investing, it gets a little bit more nuanced. So let me describe it this way.
For many, many years before the last decade or so, stocks stuff that were low price book, low price sales tended to outperform the market for a period of 30, 40 years. And what that meant is that if you were buying a company close to its book value, meaning you aren’t giving much of a premium to the value of the business underlying the purchase, then if you put a bucket of company selling at low price book, you were tending to get more than your fair share of companies that were out of favor. So it correlated well with more than your fair share of companies that were out of favor and maybe too out of favor and so you could get an excess return.
Same way as momentum has worked for 30, 40 years, not just in this country, but across the globe. Let’s say it didn’t work for the next two years. It could be that it’s just cyclically out of favor. It works over the long-term, you just have to be patient or it could be momentum doesn’t work over the next two years because the trade has become crowded and it’s degraded. And that’s why it didn’t work.
Two years from now I would know the answer. Is it — is momentum just cyclically out of favor or it was the trade now because it’s not so hard to figure out a stock used to be down here and now it’s up here? Has it become crowded and degraded because everyone knows about it?
Two years from now I would know the answer. So the way I’d answer your question is this. Low price book, low price sales momentum are all things that, in the past, had correlated with good returns. We really look for causation. And since stocks for ownership here is a business and we’re valuing them just like a private equity investor would, OK, and that’s based on cash flows, you know, are the intangibles earning money? They’re not earning money. Those are questions that translated the cash flow and how much am I paying for that cash flow and how much am I paying for that growth.
And so, you know, what we’re looking for is valuation of a business, taking all those things into account and trying to buy it at a discount. And it’s possible the market doesn’t recognize that. And, you know, if you look at the last year, if you bought every company that lost money in 2019, 2020 is — is a little messed up because of COVID and the second quarter had weird earnings, so let’s just look at the companies that lost money in 2019.
If you bought every company that lost money in 2019 that had a market cap over $1 billion, and so they’re about 261 of those and you bought every single one of those companies, you’ll be up 65 percent so far this year.
RITHOLTZ: Wow.
GREENBLATT: OK? So, you know, in that kind of market, that’s kind of frothy at that end where people are going to say, hey, this company is going to be the next Google, Microsoft or Amazon. I don’t think the froth is in the Google, Amazon and — Amazon. Those are some of the best businesses we’ve ever seen in our lifetime.
To a large extent, they — they — I don’t quibble with their valuations. I actually — we own a big chunk of those companies. We — we think they’re great businesses. But there are hundreds of companies with — that rhyme with them. So it’s really not looking at indexes or how do we classify value and growth, it’s really looking stock by stock, valuing them try to buy at a discount. And that’s causation.
And so that causation might not be popular in the next year or two, but I’m not going to stop doing that. That’s what stocks are (inaudible) shares the businesses. So that’s the best way I can answer your question.
We’re looking for causation not correlation. We’re not looking for that low price book, low price sales momentum of correlated. No private equity firm buys it.
If I came to you and said, hey, listen, I have this real estate strategy, I’m just going to buy all the houses that were up the most in the last three months.
(LAUGHTER)
You kind of look at me like I was nuts. And so although it’s correlated with good returns in the past, that’s not what I would continue doing even though it’s correlated. I’m looking for causation. That’s where I can put it.
RITHOLTZ: So let me throw a correlation/causation curve ball at you. I have seen a number of studies over the years that point out that relative to their peers that don’t do big stock buybacks, the company is doing share buybacks tend to outperform. Is that a correlation issue? Hey, they have all the extra cash and, therefore, they’re good companies to begin with so they could do buy backs or there is some causal relationship between reducing the outstanding share account and that makes your earnings appear better. What is the advantage or not of borrowing cheap money to buy shares back?
GREENBLATT: Right. Well, what you’re saying is true, and I — I haven’t looked at the studies. But if what you’re saying is true that buyback stock has correlated with good returns in the past, I would call that a correlation. Causation has to do with smart managements who only buy back stock when it’s selling at a discount to what they think it’s worth and they’re right. So in other words, there’s nothing …
RITHOLTZ: Right.
GREENBLATT: … inherently good or bad with buybacks. Some are smart when you’re buying it below what the business is worth, and some are not so smart when you’re — let’s say borrowing money to overpay for your own stock. And so both of those things are true, and I wouldn’t want to look at anything that’s happened in the past and say, oh, it’s correlated with this or that. I would look at stock by stock and see if their buybacks were made good prices relative to my assessment of value or whether we made it too high prices with borrowed money. And so they’re totally different things, so I — I wouldn’t put any weight into any study that they just looked at generically companies that buy stocks back. There’s nothing inherently good or bad about it. It depends what price they pay.
RITHOLTZ: Quite interesting. We’ve noticed a tendency among some of the companies you’ve referenced like Google or Microsoft or Amazon or what have you that it’s become less of a competitive group of firms fighting it out for clients or customer and more of the winner-take-all situation. What are your thoughts on those sort of winners and losers, what Buffett describes as companies with impenetrable moats?
GREENBLATT: Yeah. I mean, we own a lot of those businesses. You know, we have a fund that looks — you know, buys the S&P 500, all 500 stocks of the S&P 500, but overweights companies that we think are cheap and underweights those so with those all 500, but starts with the S&P index, which is market cap-weighted and then overweights companies that we think are cheap and underweights those that we think are expensive by a little bit so it doesn’t have too much tracking error. It’s, you know, sort of an index tilt.
And we have overweighted almost all those companies that you’re describing. They are some of the best businesses in the history that we’ve ever seen. We haven’t seen anything like this before — the power — and I think the Internet brings this power to these businesses. And these are moats that are very tough to beat. And so what you’re suggesting is true is true.
These are great businesses. They are dominating. It’s very hard to break into them. And so I don’t actually have a solution for shall we break them up, shall we not break them up. As an investor, I’m investing in them.
RITHOLTZ: Right. You want to be on the other side of the moat in other words?
GREENBLATT: Right. If you really look at the cash flows that — and — and the stability of the cash flows, the growth prospects for the cash flows, these businesses are priced reasonably or cheaply depending on which one. So that’s not where the froth of the market is. The froth in the market is in the hundreds of companies that I was talking about before, that people will think will rhyme with the next Amazon, Google and Microsoft. And there just can’t be hundreds of companies that do that. So I think that’s where the comeuppance will be.
And so when you talked about the difficulty of value investing, that fund just overweights what we think is cheap, according to our definition of value, and underweights has beaten the market. So even in a very tough period for value, it’s not like the principals don’t work, they do work. But when you go long/short and short some of these names that are losing money are trading at hundreds of times that people think will be the next Amazon and Google, those, I think, are writing at very high prices and will have their comeuppance and so at least I hope so. And that’s — that’s where I think the problem.
RITHOLTZ: So you deal with — you manage money professionally, you deal with allocators and others. You’re defining value in a way that’s somewhat different than the way many value investors — many less successful value investors have done so. What do you say to those people who are ready to throw in the towel on value and think now is the time to jump into growth?
GREENBLATT: Well, look, I don’t buy if I said the traditional definitions of value and growth. The reason that we overlap with value some of the times it’s because we’re certainly not growth at any price, you know, throw away the — the rule book and just buy growth at any price. So sometimes we correlate closely with company — other companies that are out of favor. And — and so those even Russell and Morningstar will put us in the — the — either the — the blend category or the value category. That’s usually where we are. We’re certainly not growth at any price.
But I do think if you’re asking me whether I think the traditional definition of value will come back at some point, yes, I do. I think it’s gone to an extreme at this point. I think it’ll come back. I don’t really care if it does or not because it’s not our definition, but I do think it’ll come back.
I think the — you should — you — a lot of managers or allocators view traditional value as an asset class, meaning, hey, I should have some exposure here. It zigs and zags differently than the market, the returns. And at some point, they’ll have their day in the sun. And so I think people will continue to allocate there, but in a limited — a more limited way because people change what works, and it’s clearly not been working traditional value.
RITHOLTZ: So imagine us five or 10 years off in the future if I were to ask you, hey, what was the one indicator, what was the one data point that was a signifier that value had come back, what particular data point or variable might that be?
GREENBLATT: That’s a great question that I don’t have a great answer for, mostly because what I said about the definition of value. So I guess what I would be looking for is companies that borrow a lot of money and lose money, don’t have and — and aren’t the next Google and Amazon. There’ll be some winners in that group, but most of them will have their comeuppance where eventually you have to earn money. That’s where I think of some of those companies have their comeuppance where, as I said, the money losers were 65 percent so far this year.
If those companies saw — a bunch of those companies have their comeuppance, I would say that, you know, there’s a chance for relative performance on — on companies that aren’t like those, but otherwise …
RITHOLTZ: So — so leverage …
GREENBLATT: … can’t answer it soon.
RITHOLTZ: Right. So leverage low– low profitable companies, some people would call that low-quality versus high-quality. Is that a ratio worth — worth considering?
GREENBLATT: You know, I — I — I hate making generalizations, so I’m not trying to avoid your questions, but we really look at the market …
RITHOLTZ: I know and I’m …
GREENBLATT: … stop by …
RITHOLTZ: … I’m trying to pin you down with a really general backwards-looking future forecast.
GREENBLATT: Yeah. No, we look at it (inaudible) — no, a lot of people asked that question. It’s a reasonable question, I just don’t have a great answer because we’re looking at things stock by stock and very hard to make generalizations about that, especially if — as I keep saying, we have different definitions.
RITHOLTZ: So for the record, let’s get your best definition of the sort of value companies that you think have the best risk-adjusted growth potential. What are the data points that you’re looking at today not for a specific name but, you know, I’m giving you an opportunity to restate the magic formula.
GREENBLATT: Right. So what I would say is right now the pre-tax cash flow yields of the S&P 500 is about four percent, a little under four percent. So there are companies that have less than a four percent yield, but much higher growth rate than the S&P in general. And there are companies that have a much higher yield, you know, five or six or seven percent that have at least as good, if not better, fundamentals and growth rate than the S&P 500. So both of those are relative values.
There aren’t a lot of companies out there that are super cheap right now. If you look historically, things are expensive. Obviously, that has something to do with interest rates being lower than normal. It has something to do with the alternatives not being there for diversification. And so stocks being one of the only games in town, so it certainly has something to do with that.
And if you told me that rates would stay permanently low, which I just don’t know, then on an absolute basis we could make some nice money from here. Otherwise, I’m in a lucky position of people give me money and say I want to put it in the stock market. What’s the smartest way to do that? And so what we’re sticking to our companies that maybe yield a little less than the S&P, but have much better growth prospects, much more secure earnings, stream great franchises, so we’re willing to buy those. We’re also going to buy companies that we can get it much higher free cash flow yields than the market that have at least as good growth, if not better and better operating fundamentals. So both of those are areas that we look at and that’s how we would define at least a relative value right now, and I think they could provide good value if rates stayed as low.
RITHOLTZ: Sounds good to me. I know we only have you for a few more minutes, so let me jump to my favorite questions we ask all of our guest in our speed round. And let’s start with what are you streaming these days. Give us your favorite Netflix, Amazon Prime or — or whatever podcast you might be listening to.
GREENBLATT: Well, the two I’ve been watching lately, one is The Mindy Project because it’s funny, and we can all use that now. And the other is The Americans because it’s just great drama. So I guess a lot of people are streaming during COVID and, you know, it’s been a horrible thing for so many people. But those are my two suggestions there.
RITHOLTZ: I’m going to put those both on my list. Tell us about your early mentors, who — who guided your career, who affected the direction you move professionally.
GREENBLATT: Well, you know, I have to start with my dad. He was a businessman. He was a shoe manufacturer and I learned ethics and actually how business works on a day-to-day basis at the dinner table. He always shares with us. I got to work with him first couple of summers. And, you know, I — someone I truly admire. He’s still with us and, you know, I — I — I love him a lot, a great mentor.
And then there’s, of course, Graham and Buffett. You know, I went to Wharton. I was learning about efficient markets. It didn’t make much sense to me. I read an article about Ben Graham then started reading everything that he wrote and everything about him. And then, of course, he mentored Warren Buffett who made that little twist buying a good business cheap that made him one of the richest people in the world.,
And both of those people shared what they learned with others, and — and that’s one of the reasons I write, one of the reasons I teach is because of their example. And so they have been great early mentors for me.
RITHOLTZ: Let’s talk about books. Tell us some of your favorite books and — and what are you reading currently.
GREENBLATT: Well, two most recent books I read, one was called “The Splendid and the Vile,” by Erik Larsen. It’s about Churchill’s first year in the office which, of course, when things — everything was going wrong, they put up an office days before it looked like England was going to fall. So how he handled that was really amazing to read and great, great, great book.
I love anything about Benjamin Franklin, so I — I just read a latest thing from Gordon Wood, “The Americanization of Ben Franklin,” so I enjoyed that very much. And if you haven’t read much about Ben Franklin, that’s what I would suggest.
And then I read a book called “Chasing My Cure,” by Dr. David Fajgenbaum who actually cured himself of a orphan disease that no one had lived from before. And he was in medical school when he was diagnosed with this disease. They didn’t know what was wrong with him, and it was going to be fatal in a few years. And the book is called “Chasing My Cure,” and it shows how he actually cured himself and lots of other people that have this disease. And it was fascinating and now he’s attacking COVID in the same way. He’s looking for existing drugs that may act well on something that doesn’t have a drug of its own. And so he’s been working on that. And it was a very inspiring book, so that’s called “Chasing My Cure.” And — and believe it or not, it’s a page turner.
RITHOLTZ: Sounds fascinating. What sort of advice would you give to a recent college graduate who was considering a career in asset management?
GREENBLATT: Well, I don’t want to be cliché, but if you’re lucky enough to find something that you’re passionate about, that you can do for a living, that’s a gift. Buffett calls it “dancing to work every day.”
And the only people I would suggest that go into it are people who feel that way, to go into this business just for the money, you know, and — and many aspects of it pay — pay well. I don’t think it’s a great choice, but if you really love it, you can help a lot of people, which they’re investing and you can do good things with the money that you do earn if you’re successful at it. So I highly recommend it, but really only if you’re passionate, you love the work. So that would be my best advice.
Pick something else. There’s a lot of ways you can contribute to society that don’t involve asset management. So if you love it, I’m all for it. If you’re doing it for the money, pick something else.
RITHOLTZ: Our final question, what do you know about the world of investing today that you wish you knew when you started out 30 or so years ago?
GREENBLATT: Sure. Well, I got into investing, reading Ben Graham. And — and one of the first articles I read were what Warren Buffett would call “cigar butt investing,” you know, buying net-net stocks. And I actually wrote an article with some of my classmates — my master’s thesis that was published in the Journal of Portfolio Management on net-nets. And they worked pretty well.
And, you know, as I said, Buffett made that little twist that made him one of the richest people in the world even though he’s a student of Graham. He said, “If I can buy good business cheap even better, quality matters a lot even more now than it did 30 years ago.”
You need to invest in a good business. If you think about investing as not trading, but buying companies you’re going to hold for a long time, of course, you want to be in a good business that has a good franchise and grow for a long period of time. Of course, it’s an art to figuring that out. But to the extent that you can concentrate on those areas and also look for bargains, you know, combination of things, you don’t want to overpay for those things. But if you can pay a reasonable or a cheap price for those things, concentrating on quality is a key that I — I learned probably, I started about 37 or eight years ago. I probably learned it about 30 years ago, and I — and that’s the most important lesson I’ve learned in that period of time.
RITHOLTZ: Quite fascinating. Thank you, Joel Greenblatt, for being so generous with your time. That was Joel Greenblatt. He is the author of numerous books, including “Common Sense: The Investor’s Guide to Equality and Opportunity.” He is also the co-founder/CIO of Gotham Asset Management.
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I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.
