Book Review: “The Little Book That Still Beats the Market” by Joel Greenblatt

Attempting to beat the market is a frequent cause for investors to lament that markets can stay irrational much longer than they can stay solvent. Yet, a common error is to treat the market as completely arbitrary, as the game still has a set of rules.

In The Little Book That Still Beats the Market, Joel Greenblatt exhorts investors to follow a disciplined set of investing principles. With his “Magic Formula” and other fundamentals, he claims investors can achieve success and beat the market over the long term. While there is never a silver bullet – i.e., a simple solution to a complicated issue – investors may be able to maximize their gains and build wealth by applying Greenblatt’s strategies.

About the author

Joel Greenblatt is one of the 50 most famous American investors according to Yahoo Finance, and an adjunct professor at the Columbia University Graduate School of Business where he teaches “Value and Special Situation Investing.” At 28 he founded Gotham Capital, a hedge fund that had an initial capital of USD 7 million and achieved a staggering 40% annualized returns over a nine-year period.

In 2005, Joel Greenblatt published The Little Book That Beats the Market. The work sold over 300'000 copies, became a New York Times Best-Seller, and is still considered a classic of finance literature. Just five years later, Greenblatt updated and re-released the work as The Little Book That Still Beats the Market with data and analysis covering the 2007–09 financial crisis. The book became well-known for Greenblatt’s deep understanding of value investing and how to apply fundamentals in real-world scenarios.

A critical premise of Greenblatt’s book is to keep it simple. Few are better than Greenblatt at cutting through market noise and staying focused on time-tested strategies.

Key Insights

1. Implement the Magic Formula in your investment strategy

The Magic Formula is a simple investment strategy focused on identifying shares with high value-add potential. The formula uses a set of quantitative screens to eliminate certain companies and rank the remainder in order of the highest earnings yields and returns on capital.

Greenblatt recommends adding from 5 to 7 high-earning shares to the portfolio every few months until reaching a total of between 20 and 30. Once this is done, he emphasizes diversification and stresses the importance of concentrating investments. Find undervalued stocks and buy them while selling any that are overvalued – this is the Magic Formula in practice.

Thereafter, as stocks in our portfolio reach the one-year holding mark, we will replace only the 5 to 7 stocks that have been held for one year.
— Joel Greenblatt

Greenblatt suggests that by building and rebalancing the portfolio over time, reasonably high returns can be achieved. Well-chosen investments should have better returns in the long term because of the due diligence done when selecting them. By rebalancing consistently, investors help ensure each investment is in the right place and truly serves a purpose: preserving and multiplying one’s wealth – although at Moonshot we favor the passive investing method as “if you don’t find a way to make money while you sleep, you will work until you die.”

In The Little Book, Greenblatt warns that profitability is sometimes forsaken for potential. After the post-2008 tech boom, many investors became obsessed with finding a unicorn; they started betting on potential instead of profit. A problem with this strategy, according to the author, is the susceptibility to herd mentality. Investors flock to what’s popular without assessing an investment’s true value.

Greenblatt emphasizes the importance of ignoring the hype and instead focusing on high earnings yields and high returns – according to him, the most crucial indicators for long-term success.

2. Target a long term when investing

Unlike the less emotional, less volatile passive investing method, with the Magic Formula investors can easily find themselves being reactionary and making impulse decisions in the excitement of market swings. Greenblatt cautions investors to keep in mind market dynamics, echoing Benjamin Graham’s wisdom that the markets are a “voting machine in the short term, but a weighing machine in the long term.”

In the short term, everything is volatile and no one is bigger than the market, because beating it involves anticipating “random” swings. However, over the long term, the market behaves more like a weighing machine because it reveals the intrinsic value of companies.

Over the short term, Mr. Market may price stocks based on emotion, over the long term Mr. Market prices stocks based on their value.
— Joel Greenblatt

That is precisely why keeping a long-term view while investing is imperative. Do not react instinctively to volatility but weigh and measure market events.

3. Make your goal to outperform the ‘average investor’

The Little Book That Still Beats the Market highlights another key concept that lies in surpassing average returns. This can be achieved by consistently applying principles that mitigate the emotional aspects of investing. Success lies in maintaining discipline when the ‘average investor’ may falter. The author believes investors can outshine even the most seasoned professionals by employing fundamental analysis and adhering to a well-defined, rule-based framework.

Many studies over the years have confirmed that value-oriented strategies beat the market over longer time horizons.
— Joel Greenblatt

4. Don’t ignore the importance of fundamental analysis

Decried by some as antiquated, fundamental analysis is the bane of avant-garde investors. However, Greenblatt stresses in his book that fundamental analysis is crucial – and this is no surprise given his Magic Formula and focus on long-term investing.

Fundamental analysis involves studying a company’s economic and financial information, as well as other factors related to the company and its industry, to find and invest in those that are undervalued. Typically, this is done by analyzing the financial statements of the company and making an informed decision based on that data.

Conclusion

At the core of The Little Book That Still Beats the Market lies the Magic Formula, which emphasizes simplicity, discipline, and knowledge. Central to Greenblatt’s approach is:

• Sticking to the Magic Formula, which assesses companies by their price and returns on capital
• Keeping focused on the long game when it comes to investing
• Aiming to outperform the crowd in your investment strategies
• Using fundamental analysis to identify high-potential companies

While Greenblatt doesn't guarantee success, adhering to the fundamental principles he espouses could enable investors to similarly grow their wealth and optimize their investment portfolios.