A detailed explanation Joel Greenblatt's Magic Formula Investing strategy and a review of his hedge fund's current stock holdings.
The Value Guru
Joel Greenblatt is an investor, writer and academic. He is probably best known for the books he has written, but also manages funds and frequently lectures on investing. He has developed a very specific style of value investing, termed Magic Formula Investing, which has permeated his writing and investing businesses.
He started Gotham Capital in 1985 with $7 million in seed capital from famed junk bond investor Michael Milken. Between 1985 and 1994 the fund generated returns of 34% per annum. He then returned money to investors but continued to manage his own money in the fund. Between 1985 and 2006 the fund generated returns of 40 percent per annum.
In 1997 Greenblatt wrote You Can Be a Stock Market Genius and in 2005 he wrote The Little Book that Beat the Market. Both were bestsellers, and continue to feature on lists of the best investment books to read. Then in 2010, he wrote a follow-up, The Little Book that Still Beats the Market and in 2011 he published his fourth book, The Big Secret for the Small Investor.
In 2009 Greenblatt relaunched his company as Gotham Asset Management, which he runs together with Robert Goldstein. In 2012 the firm launched a series of long/short mutual funds to complement its hedge funds. The firm’s most recently launched fund, the Gotham Index Plus fund, combines active and passive investment strategies. In 2016 the fund outperformed 95% of its peers.
However, Gotham’s funds have had mixed results since 2012. Value investing has fallen out of favor, and returns for long-short funds have been hurt by the performance of short positions. In 2015, all the funds lost money and underperformed their benchmarks, resulting in withdrawals. The funds have since recovered and as of 2017, the firm has $11.6 billion under management.
In 2009 Greenblatt started Formula Investing, an online money manager. The site is now a free stock screener, which anyone can use to filter stocks according to his formulae. He also runs a website called the Value Investors Club, where 250 members exchange their best value investing ideas.
Greenblatt is an adjunct professor at the Columbia University Graduate School of Business where he teaches "Value and Special Situation Investing." He supports education focussed charities in New York and has a special interest in Charter Schools.
The Magic Formula
Joel Greenblatt’s basic formula follows a process of first eliminating certain stocks and then ranking the rest according to earnings yield and return on capital.
He excludes stocks with a market cap below a minimum threshold (usually $50 million) as well as foreign stocks - their earnings may be swayed by currency movements. He also filters out stocks in the utility and financial sectors.
For the remaining stocks, he determines the earnings yield, using EBIT/EV and return on capital using EBIT / (net fixed assets + working capital). Then he ranks all stocks according to their earnings yield and return on capital.
He invests in the 20-30 top-ranked stocks, usually allocating capital to 2 to 3 stocks each month. The portfolio is rebalanced annually. Greenblatt stresses that the process must be followed over a 10-15-year period to generate good returns.
Gotham’s funds all use some variation of this formula but include short positions for the lowest ranked stocks.
Gotham Capital's Latest Form 13F Filing
On November 14th, 2017, Joel Greenblatt's firm Gotham Capital filed their quarterly Form 13F regulatory filing. I reviewed the 13F filing to review holdings in Gotham Capital's large portfolio.
Gotham Capital's stock portfolio totals nearly $6.8 billion according to the latest filing. The list value of stock holdings is down -4.6% when compared to the last quarter. As a benchmark, the S&P 500 was up 3.9% over the same period.
Quarter-over-Quarter Turnover (QoQ Turnover) measures the level of trading activity in a portfolio. Gotham Capital's QoQ Turnover for the latest quarter was 36.0%, so the firm appears to trade a significant percent of its portfolio each quarter.
Gotham Capital's Largest Holdings
The Ideas section of finbox.io tracks top investors and trending investment themes. You can get the latest data on the holdings discussed below at the Joel Greenblatt page. The following table summarizes his firm's largest holdings reported in the last filing:
|Ticker||Name||Holding ($mil)||% Of Portfolio|
|LOW||LOWES COS INC||$65.6||1.0%|
|AMAT||APPLIED MATLS INC||$64.9||1.0%|
|CVS||CVS HEALTH CORP||$59.1||0.9%|
|FOXA||TWENTY FIRST CEN...||$59.1||0.9%|
|CAT||CATERPILLAR INC DEL||$57.6||0.8%|
The seven positions above represent only 6.5% of the hedge fund's total portfolio.
Gotham Capital's 7 Largest Purchases
I also used finbox.io to find Gotham Capital's largest buys last quarter. Here's the list of the biggest stock purchases determined by comparing the last two filings:
|Ticker||Name||Purchased ($mil)||% Of Portfolio|
|LMT||LOCKHEED MARTIN CORP||$37.1||0.5%|
|CLX||CLOROX CO DEL||$35.3||0.5%|
|MO||ALTRIA GROUP INC||$34.9||0.7%|
|EA||ELECTRONIC ARTS INC||$27.2||0.7%|
|AAP||ADVANCE AUTO PAR...||$25.3||0.4%|
Gotham Capital's 7 Biggest Sells
Here's the list of biggest position reductions determined by comparing the last two filings:
|Ticker||Name||Sold ($mil)||% Of Portfolio|
|EMR||EMERSON ELEC CO||$54.1||0.0%|
|URI||UNITED RENTALS INC||$42.6||0.6%|
|ADM||ARCHER DANIELS M...||$31.2||0.4%|
|PG||PROCTER AND GAMB...||$27.4||0.0%|
|JCI||JOHNSON CTLS INT...||$26.1||0.4%|
Gotham Capital's Best Dividend Yields
The next ranking table lists the stocks in Gotham Capital’s portfolio with the best dividend yields. Dividend seekers can appreciate stocks that earn upwards of 6% excluding price appreciation and are also backed by a prominent investor.
|Ticker||Name||Dividend Yield||% Of Portfolio|
|SFL||SHIP FINANCE INT...||9.4%||0.1%|
|NEWM||NEW MEDIA INVT G...||8.8%||0.0%|
Gotham Capital's Recent Price Pull-Back Stocks
To find stocks in his portfolio that may be unpopular at the moment and trading at cheap valuations, I ranked his holdings by price pullbacks. The ranking table below lists the stocks in Gotham Capital’s portfolio by stock price performance over the last 30 days.
|Ticker||Name||Price 1-mo Ago||Current Price||% Change 1-mo|
|OSIS||OSI SYSTEMS INC||$90.29||$67.13||-25.7%|
|SIG||SIGNET JEWELERS ...||$70.81||$52.77||-25.5%|
Managers with more than $100 million in qualifying assets under management are required to disclose their holdings to the SEC each quarter via 13F filings. Qualifying assets include long positions in U.S. equities and ADRs, call/put options, and convertible debt securities. Shorts, cash positions, foreign investments and other assets are not included. It is important to note that these filings are due 45 days after the quarter end date. Therefore, Gotham Capital's holdings above represent positions held as of September 30th and not necessarily reflective of the fund's current stock holdings.
However, most can agree that with thousands of stocks traded on U.S. exchanges, doing thorough research on each one is nearly impossible for smaller investors. Leveraging the resources of the largest hedge funds on Wall Street can be a powerful way to narrow down the list.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.
Author: Matt Hogan
Expertise: Valuation, financial statement analysis
Matt Hogan is a co-founder of finbox.io. His expertise is in investment decision making. Prior to finbox.io, Matt worked for an investment banking group providing fairness opinions in connection to stock acquisitions. He spent much of his time building valuation models to help clients determine an asset’s fair value. He believes that these same valuation models should be used by all investors before buying or selling a stock.
Matt can be reached at firstname.lastname@example.org.