Top positive review
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Awful title, Excellent book
on 10 January 2008
1999 Fireside reissue of 1st edition (1997), 299 pages (of which 261 pages form the main body of the book).
Despite the awful title, I really enjoyed `You can be a Stock Market Genius'. Greenblatt laces his (excellent) content with plenty of jokes, which I always think of as a somewhat risky approach: some readers who would otherwise appreciate the content will not like the delivery.
By the time of publication, Greenblatt's investment firm had already achieved 50% compound annual growth for 10 years, so could write his book however he pleased. I like it when people don't need to write books for financial reasons - you get a better look at the author.
Greenblatt's book reminds me strongly of Mohnish Pabrai's `The Dhandho Investor', which I read a few months ago. I don't think one should be particularly surprised, as they both belong in that tiny group of investors who have not just beaten the stock market, but have absolutely smashed it. The following summary points for `You can be a Stock Market Genius' could be used for either book:
1. Concentrate your efforts on areas where bargains are likely to occur ("If you preselect investment areas that put you ahead of the game even before you start ... the most important work is already done.")
2. Limit downside risk ("If you don't lose money, most of the remaining alternatives are good ones.")
3. Load up on only a few best ideas ("...don't screw up a perfectly good stock-market strategy by diversifying your way into mediocre returns.")
The second point, which is the same as the concept of `margin of safety,' works because it - unlike the world of analyst earnings forecasts - acknowledges the severe uncertainty that is reality. I particularly enjoyed Nassim Taleb's `The Black Swan', partly because the world he reveals ties in so well with the `value' approach to investing. Both good and bad large, unpredictable events occur more frequently than we expect. If you organise your investing (and your life) so that you are protected from some of the negative shocks, but left exposed to the positive ones, this is likely to serve you well.
Pabrai focuses on distressed situations (what he calls `high uncertainty, low risk') and Greenblatt likes special situations (spin-offs, merger securities, etc). But the theme is the same: in order to get really good results you've got to be looking in areas other people are not.
Greenblatt is willing to concentrate more than Pabrai, who simply limits his positions to a maximum 10%, to protect himself against error. But these are differences in style rather than substance. They both look for promising situations/ideas and only then do the necessary work. Both profess to avoid use of Excel spreadsheets (In 2006 Greenblatt was asked if he used spreadsheets: "I really don't know how to build spreadsheet models. But the good news is that you don't need spreadsheets to make money.") In other words, they keep it simple.
Before he gets into the specifics of special situation investing, Greenblatt spends a chapter going over `some basics'. This short section of the book is either an excellent primer or reminder of the general requirements of a successful investment strategy - and I commend it to you without reservation.
His book also contains some excellent advice about selling. It is something I have been thinking about a lot recently after reading Pabrai's `The Dhandho Investor' and Katsenelson's `Active Value Investing' - both of which make a strong case for the need to learn to sell in order to get significantly above market returns. The problem with this advice is that selling well is somewhere between extremely difficult and impossible (as various super investors, such as Greenblatt, Marty Whitman, Munger, etc. have said).
Greenblatt's advice is very simple:
"The bargain created or unmasked by the special corporate event - that's what draws me in. The quality and nature of the business - that's what usually determines how long I stay. So trade the bad ones, invest in the good ones."
(You may note that this is essentially the same as Buffett's counsel, who wrote: "when we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever.")
I was struck by how often Greenblatt rammed home the importance of incentives throughout his book:
"Insider participation is one of the key areas to look for when picking and choosing between spinoffs - for me, the most important area."
His understanding of the critical importance of incentives is very wise and is surely one of the key reasons for his outstanding success (although I wonder if he still holds stock options in such high regard, now it is clearer that the lack of downside risk can encourage excessively risky behaviour?). Charlie Munger said this about incentives in `The Psychology of Human Misjudgement':
"...almost everyone thinks he fully recognizes how important incentives and disincentives are in changing cognition and behaviour. But this is not often so. I think I've been in the top five percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I've always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive super-power."
It's also one of the reasons why I like Karen Pryor's book, `Don't Shoot the Dog,' so much. Munger pointed out in the same talk I quoted him from above, that what economists call `incentives' is the same as what psychologists call `reinforcement'. Reading an excellent book on training using positive reinforcement (like Pryor's) is thus extremely useful in improving your understanding and critically, practice of making use of incentives.
So long as you're not the type who objects to a light-hearted approach, you're likely to find Greenblatt's book a lot better than the title suggests. Highly recommended.