“You Can Be a Stock Market Genius” by Joel Greenblatt


The Book

“You Can be a Stock Market Genius” is Joel Greenblatt’s classic 1997 book. Don’t be dissuaded by the ridiculous title. This is a money making handbook for the small investor who is willing to get their hands dirty and do a lot of homework.

Joel Greenblatt is one of the best investors of all time.  I reviewed another book of his: The Big Secret for the Small Investor in this blog post.

The two books have the same philosophical value investing orientation but are polar opposites in terms of difficulty. The Big Secret is for passive buy-and-hold investors who don’t want to deal with all of the homework of actively picking stocks. You Can Be a Stock Market Genius is a homework-intensive strategy that Joel employed when he was running his hedge fund from 1985-1995 and achieved 50% annual returns.

No passive strategy will get you 50% returns. No systematic quantitative approach will get you 50% returns. Achieving that kind of stellar performance requires a hell of a lot of work and luck. The book is Joel’s outline of the various hunting grounds that he used to generate those amazing returns.

The Small Investor’s Advantages

The book opens with an inspiring message. The small investor has advantages over prominent professionals. Big professionals managing billions of dollars in capital can’t: (1) concentrate in a handful of small positions, (2) take the career risk of dramatically underperforming the benchmark (they’ll get fired), (3) won’t invest the time and resources necessary to investigate weird and tiny situations that they can’t allocate a significant portion of their capital to.

A small investor can do all of those things.

In a world where ETFs with 50 positions are considered “concentrated”, Joel’s definition of “concentrated” is wildly different than the mainstream view. The mainstream view is that “risk” is volatility of returns and “risk” can be reduced by holding more positions. Joel suggests that as few as 8 stocks in different industries is sufficient to properly diversify a portfolio.

8 stocks would result in so much volatility that it would be career suicide for any professional investor. Most people can’t handle volatility. A small investor with the right temperament can. Unfortunately, most small investors squander this advantage. We’re never going to beat Wall Street at their own game: namely, smoothing out returns and reducing volatility (i.e., pain) with fancy financial engineering.

What we should do is focus on the advantages that we have: (1) Temperament – If we have the proper temperament to endure volatility, we can achieve better results. (2) Size – If we’re willing to focus on areas that are hated and ignored, roll up our sleeves and do the work, we can concentrate in situations that Wall Street pros can’t.

I did some backtesting of my own a few months ago to test the limits of concentration. I looked in a Russell 3000 universe with a straightforward strategy of buying the cheapest stocks on an EV/EBIT basis. I constructed portfolios rebalanced annually beginning with 1 stock (the cheapest in the universe) and then just adding the next cheapest. I then plotted the monthly standard deviation of returns (Wall Street’s definition of risk – which is a flawed concept, but whatever).


It looks like Joel Greenblatt is correct. Most of the volatility is meaningfully reduced with a handful of positions. He offers a caveat, however, and suggests that if you are going to run a concentrated portfolio, it is best to diversify among a group of different industries. In today’s market, for instance, it may be tempting for a value-driven bottom feeder like myself to own 10 retail stocks. This would be a bad idea.

Wall Street pros and most investors have no stomach for volatility. We saw a vivid example of this in February. The market fell 10%. This is a remarkably normal event in the grand scheme of things. I was on vacation at the time that this happened and couldn’t help but laugh at the insane overreaction to this little event. It generated headlines like this: “Stocks Plunge and Traders Panic” – The Wall Street Journal, “Dow falls more than 1,000 in biggest daily point-drop ever” – thehill.com

If you want to achieve better than average results, you need a better than average temperament to ignore this nonsense.

How to think about the market

Joel tells two stories in the book that represent excellent ways to think about the stock market.

The first is a story about his in-laws. His in-laws were amateur art collectors. They weren’t looking for the next Rembrandt or Picasso, they were looking for small-scale mispriced works of art. They went to yard sales and flea markets looking for paintings that were cheaper than their value. They would find paintings that were at the yard sale for $100 that they knew were worth $1,000, for instance.

This is a useful way for small investors to think about the stock market. The professionals need to find the next Rembrandt and Picasso. We should let them fall over themselves trying to figure out what company is going to be the next Facebook or Microsoft. Most of them will fail and a handful will be lauded as geniuses (they were probably just lucky). For us, we can achieve satisfactory results by merely finding things off the beaten path that is a decent discount against their intrinsic value.

Joel tells another great story where he went to the best restaurant in New York, Lutèce. Joel asked one of the chefs if an appetizer on the menu was good. The chef replied with: “it stinks.” The message was clear: it didn’t matter what you ordered off the menu. Everything was excellent because Joel was at the best restaurant in New York. The best way to invest in the stock market is to identify those places that are the best places to invest, where no matter what you pick, the chances are that it will be good.

The book outlines some key hunting grounds where Joel had success finding these opportunities.


The goal of investing is to find mispriced assets. You want to seek out areas of the market where stocks are prone to mispricing.

One area that Joel finds to be replete with mispricings is spin-offs. Spin-offs are divisions or subsidiaries of a larger company. The larger company decides to “spin off” that piece into a separate company.

Why do companies do this?  They may think that if they isolate the entity in the market, it will be able to command a higher valuation.  For instance, let’s say (in an extreme example) that an insurance company owned a financial software division. Software companies have higher P/E ratios than insurance companies. However, the market might not appreciate the software company because it is buried in an insurance company. If they spun it off – the software company would probably command a higher valuation if it were isolated.

The larger firm might also want to separate itself from a “bad” business that is weighing it down. They might just want to use the spin-off to unload debt on a smaller firm. There could be tax or regulatory reasons. They might have difficulty selling the business, so they decide to dump it in the form of a spin-off.

Whatever the reason, spin-offs are prone to mispricing. This is because institutions and people often sell them for reasons other than the intrinsic value of the company. Some institutions might not even be allowed to own it due to small market capitalization, or it doesn’t fit into their “strategy.” Individual investors probably wanted to hold the larger business and have no interest in owning something completely different. In any case, spin-offs are prone to indiscriminate selling, which creates mispricings and opportunities for smaller investors like us.

In the book, Joel takes you through several real-world examples of spin-offs. He explains why the spin-off was pursued and why he thought it was an attractive opportunity to invest in.

Currently, I own one spin-off in my portfolio: Madison Square Garden Networks (MSGN). My rationale for holding it is described here. I became aware of the opportunity when looking at a list of recent spin-offs back in 2016.


Joel then moves onto mergers as an opportunity for mispricings.

He first addresses the obvious: merger arbitrage. Merger arbitrage is buying a stock after a deal is announced and trying to earn a spread between the buyout price and the market price. For example, let’s say a company is trading at $30 and another company buys it out for $40. As soon as the deal is announced, the stock will rally to $39. A merger arbitrage strategy would buy the stock at $39 and wait for the deal to be consummated.

Joel thinks this is a dumb strategy and I agree with him. The reason is that you are taking on the risk of the deal not going through, in which case the stock will plummet. Mergers fall apart all the time, usually for regulatory reasons. Why take on that risk to make a measly 2.5% gain in the example I provided (in the real world, those spreads are even smaller and keep getting smaller as more people become involved in merger arbitrage).

It’s a strategy that might make sense for a big institution that can hire lawyers and analysts to know for sure whether a deal will indeed go through, but that’s not something small investors like myself can take advantage of.

Where Joel does believe there are opportunities for investors is in the world of merger securities. Often, a buyout can’t be financed entirely with cash and debt. Sometimes, strange derivative securities are sold (usually warrants) to fund a piece of the transaction. Investors will often indiscriminately unload these merger securities, and this will create mispricings.

The difference between a warrant and an option is that a warrant is issued by the company. That’s it. Both of them are merely a contract to buy or sell a stock at a pre-determined price on a future date.

Joel thinks this is a good area of opportunity. I don’t disagree, but I think that pricing merger securities are beyond the abilities of most small investors like myself. I’ve never owned an option or warrant in my life and place it in my “too hard” pile. You might want to tackle it and more power to you.

Like the spin-off section, Joel takes you through a few real-world examples of times that he purchased merger securities and did very well. I think the strategy is too hard to implement for the small investor, but you might disagree.


Emotions create mispricings. Greed and comfort with consensus create insane valuations for amazing companies. Revulsion, hatred, and fear create mispricings among “bad” companies. Nothing generates an “ick” feeling more than bankruptcy.

Joel does not recommend buying stock in bankrupt companies (that’s in the “too hard” pile”). The reason is apparent: equity holders can get wiped out in a bankruptcy. He does believe that the debt of bankrupt companies is often mispriced and offers incredible mispricings. Unfortunately, distressed debt investing is not only challenging to research for small investors but frequently impossible for anyone but an institution to invest in.

He believes that small investors can invest in companies emerging from bankruptcy or going through a restructuring. Often, a company went bankrupt only because it was loaded up with too much debt. They might have a viable business model that was merely being weighed down by too much debt. After emerging from bankruptcy or going through a healthy restructure, it may give the company an opportunity to shine. Meanwhile, the stigma of the bankruptcy creates a nice discount from intrinsic value.


Most classic value investors (me included) think that options are an area that is best for most people to avoid. I agree with this sentiment. Options (and warrants, which are the same thing) are a zero-sum game. Only one side of the trade wins: either the person who wrote the contract will win, or the person who bought the contract will win. They can’t both make money. Zero-sum games are usually areas of the market that are difficult for small investors to make money.

Joel takes a bit more of a liberal attitude towards options. While he doesn’t recommend actively trading options, he does suggest using long-term options (LEAPs – options contracts that mature in over a year) as a way to leverage up the return on a value stock. A LEAP will experience much more significant price swings than the overall stock. If a reasonably priced value stock experiences a 20% gain, for instance, the underlying LEAPs contract will experience a much more significant increase. It’s a way of leveraging up the bet, with the caveat that if the stock falls below the strike price, it will expire worthless. More risk, more reward.

Joel does not recommend that these bets comprise a significant portion of a portfolio, but argues that they can serve a place to amplify returns.

For me, I put all of this in my “too hard” pile. When I contemplate buying options or warrants, it sounds to me like someone saying “Let’s try crack. What could go wrong?”


You should read this book! My brief summary doesn’t do the book justice. While I gave you the broad strokes in this blog post, there is nothing like reading the book and going through the case studies which Joel provides. He provides you with his entire process: how he found out about a specific opportunity, what he liked about, where he researched it and how the idea worked out.

The first and last chapters are useful for developing a template for thinking about markets. As I stated earlier, the goal is to find mispricings. That often means going off the beaten path and finding forgotten and hated corners of the market. Joel provides a roadmap to a few areas that served him well, but they are by no means the only ways to do it.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Debt/Equity: A simple way to identify companies that can go the distance

Value Works

I could name a litany of research, books, blogs, articles all showing a simple conclusion. The conclusion is pretty basic: the less you pay for a stock relative to a fundamental metric (earnings, asset value, etc.) the more likely it is to outperform. It’s common sense and all of the research shows it works.

Much of this blog is about how these simple approaches work over the long run. Cheap stocks outperform expensive stocks. In this blog post, I performed a simple backtest against the effectiveness of different valuation metrics. My conclusion was pretty simple: every one of them works even though some work better than others.

Why does value work?

Every valuation ratio is a measure of the expectations. A low valuation implies that the market has low expectations about the prospects of the stock. Embedded in expectations are emotional and behavioral biases. Value investors exploit these emotional and behavioral biases.

Value investing “works” because other investors overreact to news because they are more emotional. That’s the essence of Ben Graham’s allegory about “Mr. Market.”

The expectations embedded in a valuation ratio tend to be false. In reality, a stock with low expectations is likely to exceed those expectations. A stock with high expectations is likely to disappoint. This is true at a macro level when looking at entire stock markets based on CAPE ratios, and it’s true at a micro level when looking at individual companies.

I like to think of a value stock as a C-average kid. All that kid needs to do to impress their parents is come home with a B on their report card. Their parents are going to be thrilled. That’s Gamestop right now. In contrast, a straight-A student that comes home with a B is going to be grounded. That’s Amazon right now. Valuation = expectations.

Why Does EBIT/EV Work?

Most research shows that EBIT/EV is the best valuation metric of all. My own above backtesting reflects this along with backtests and analysis performed by people much smarter than I.

The reason why EBIT/EV works is the focus of Tobias Carlisle’s books that I highly recommend: The Acquirer’s Multiple and Deep Value.

It works for a few reasons. Like all the valuation metrics, the enterprise multiple captures low expectations. It goes further than a standard market cap metric for two other reasons: (1) Using enterprise value in the calculation brings the strength of the balance sheet into the valuation ratio. Enterprise values also reveal the actual size of the enterprise, as debt can sometimes dwarf market cap (this is something General Motors investors found out the hard way 10 years ago). (2) The further that you move up an income statement, the less likely that the accounting numbers are prone to manipulation. This is the reason that metrics like price/sales work better than price/earnings – it’s harder for an accountant to fake sales than it is for them to fake earnings.


Always look at Enterprise Value. Market cap is just the tip of the iceberg.

How do we improve on valuation alone?

We know that low valuation metrics work and we know that EBIT/EV is the best metric of all. Joel Greenblatt sought to improve upon EBIT/EV in The Little Book That Beats the Market. He added his own quality metric: return on invested capital (ROIC). He showed that the combination delivers impressive results.

However, separate research from Tobias Carlisle in Deep Value and James Montier in The Little Note that Beats the Market shows that the “quality” component actually brings performance down.

The question is: why doesn’t return on invested capital work?

Quite naturally, a company earning high returns on invested capital will attract competition. A high ROIC is a target on a company’s back. It attracts competitors, which over the long run depresses ROIC. In contrast, a low ROIC implies that competitors are leaving the industry. The industry is likely near a cyclical trough and is about to rebound. The goal of the deep value investor is to identify these moments and buy.

Warren Buffett emphasizes high ROIC, but the key to his success is that he can identify businesses with sustainable high ROIC. In other words, companies that can maintain a high ROIC over decades. Moreover, he recognizes these businesses when their price offers a margin of safety. This is a skill that hardly any other investors have been able to duplicate. You should be skeptical of anyone who claims they can identify these companies.

ROIC is probably useless for average investors because, unlike Buffett, we don’t have the ability to determine whether or not a company can sustain it.

In that case, if ROIC doesn’t work for the average investor, then what metric improves on merely buying cheap?

Debt/Equity: A simple metric with significant results

What quality metric actually works? Ben Graham provided his answer: quality isn’t ROIC, it’s about the quality of the balance sheet.

Graham’s preferred metric was the debt/equity ratio. In 1976, Graham recommended buying baskets of 30 companies that have a simultaneously low P/E ratios and a low debt/equity ratio. His backtesting revealed that this strategy returned 15% per year.

My backtesting reveals that Graham (as usual) is right. A low debt/equity ratio improves the performance of every single valuation ratio and reduces maximum drawdowns.

My backtest only goes back to 1999, the universe is the S&P 1500, the portfolios are rebalanced annually, and the portfolio size is 30 stocks. The results are below.


As you can see, merely restricting the backtest to a population of companies with a debt/equity ratio below 50% (i.e., they have triple the assets that they have in debts) improves every single valuation metric that I tested. It seems absurd that such a simple metric would vastly improve the performance of every valuation metric, but that’s the result.

Why is this the case?

I think it is because any company whose stock has a cheap valuation is going to be in some type of trouble. The strength of a balance sheet is the reason that a company survives the crisis that it is mired in.

For most value stocks, all that they need to do to thrive is merely survive. There is nothing that guarantees survival more than a strong balance sheet. Usually, these companies are in an industry that is going through a difficult time (like retail right now). When the industry is going through a tough time, competitors go out of business or leave the industry voluntarily. When the competition is gone, the stage is set for the industry to come back to life. When the industry comes back to life, the survivors reap the rewards.

In the retail sector right now, the casualties are going to be the highly leveraged firms. An excellent example of this is Sears. Sears currently has negative equity and is highly leveraged (debts exceed assets). The Sears balance sheet is probably not strong enough to survive the “retailpocalypse”. In contrast, a company like Foot Locker (one of my holdings) has a strong balance sheet and will likely survive the shakeout. There is no way to know for sure, but common sense tells me that this is the likely outcome.

The survivors of an industry decline will have plenty of reasons for why they survived: Our management is excellent, our product is better, we have strategic vision, our employees are just so damn good, blah blah blah MBA buzzwords.

The real reason the company survived is that it had a stronger balance sheet than everyone else going into the downturn. The balance sheet made the company survive the tough time and hang in there longer than everyone else — in other words, a company with a good balance sheet can survive. As Rocky Balboa might have put it, the company can “go the distance”. In battered industry going through a crisis, all that a company needs to do to win is go the distance and survive.


The lesson of Rocky: Going the distance is the same thing as winning.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.


2017: A Year In Review

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My Performance

My performance was, in the words of Benjamin Graham, unsatisfactory. I lagged the S&P 500 substantially.


The S&P 500 was a mighty opponent this year. It was like the Kurgan in Highlander, or perhaps the T-1000 in Terminator 2. It kicked my butt. The market steadily increased with minimum volatility and drawdowns. It was quite possibly the most perfect stock market rally in history.

The road to my return was also far rockier than the S&P’s. As recently as August, I was down 4.8%. My portfolio recovered 12.5% from those levels in the last few months. The S&P, in contrast, increased every month this year in a smooth and unstoppable fashion.


The S&P 500 was not to be trifled with this year.

Much of my underperformance is attributable to the underperformance of value investing as a strategy. This is to be expected. We’re in the late stage of a bull market. Value underperforms in the late stages of bull markets. In the late stages of a bull market, the stocks that shined the most during that bull market are going to be propelled forward by momentum while the laggards (i.e., beaten down value stocks) are going to be ignored or pushed down further.

Every AAII value stock screen underperformed the market this year. The lowest decile of EBIT/EV returned 8% this year, lagging the S&P 500 by 10%. The last time that EBIT/EV exhibited this level of underperformance was in 1999 when it lagged the index by 12%.

The parallel with 1999 could be an excellent thing. After 1999, from 2000-2003, value stocks went on to experience a substantial bull market while the indexes declined. The outperformance of value was significant during that time period:


Will value investors be as lucky as they were during the 2000-2003 period? I hope so. A more likely scenario would be that value will go down in the next bear market with everything else, then recover nicely. There is no way to know for sure, which is why I will simply stick to the discipline at all times.

While there are psychological underpinnings to the current environment, it is also driven by the perverse nature of indexing. Index funds pile more money into the best-performing stocks of the index. As a stock goes up, the index fund buys more of it. As a stock goes down, the index fund sells it.

When investors look at the recent returns for index funds, they pour money into them. The index funds then go out and buy based on market cap, giving momentum to the companies with the highest recent market cap gains. When money is pouring into index funds, it fuels momentum in the top performing large-cap stocks. This happened in the late ‘90s, and it is happening again.

The best performers of a bull market are rewarded even more because of the money being pumped into index funds. Companies like Amazon, Apple, Google, Netflix, and Tesla expand their market caps. In the ‘90s bull market, it was Microsoft, Oracle, Intel, Cisco and General Electric. They did well throughout the bull market and then experienced a manic frenzy at the very end.

The critical thing to realize about these moments is that they’re not caused by any change in the fundamentals. They are caused solely by money pouring into index funds, which rewards large market capitalization stocks with price momentum and punishes underperforming stocks further.

I have no idea when the current environment will end. I just know that it will end eventually. This might be 1999. It might also be 1996, and this thing might just be getting started.

What I try to do is take a long-term perspective: I am invested in stocks purchased at attractive valuations with safe balance sheets. It is unpredictable what years will deliver the returns, but I am confident that over the long run I should be able to beat the market if I stick to this approach.

Value investing is pain. Value investors don’t earn their return when the strategy is working. They earn the return by enduring the pain when it isn’t working. The pain is how we make our return. If this were easy, everyone would do it, and these bargains would disappear. There isn’t a way to time it. We have to consistently maintain our discipline and buy with a margin of safety. We have to avoid fads. We have to stay away from what’s cool. We have to maintain the discipline. The concepts of value investing are simple. Sticking to those concepts through thick and thin is not. It’s simple, but it’s certainly not easy.

Mistakes & Goofs

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All of my underperformance isn’t attributable to the underperformance of value investing, though. I made specific mistakes and blunders this year which caused a good portion of my underperformance.

I made many mistakes in the last year. I think errors are fine, as long as you learn from them. Below are my biggest mistakes of the year. I learned the following lessons from all of them: (1) Do more homework, (2) Revisit the thesis when the company posts an operating loss, (3) Stay away from asset managers, (4) Don’t panic. Let Mr. Market do that.

Cato Corp (CATO)

CATO was a retail stock I purchased for an attractive valuation and dividend yield. I bought it for the same reason I bought my other retail stocks: I think sentiment against the industry is too negative. However, CATO was in a state of fundamental deterioration when I purchased it. The first time that the company posted an operating loss in January, I should have exited the position.

Lesson learned: when a company you own posts a loss in operating income, revisit the thesis. Going forward, if a company shows such apparent signs of a deterioration in the fundamentals, I think I should admit that I was wrong in my analysis and get out.

I lost 51% on my position in CATO.

Manning & Napier (MN)

Manning & Napier is a small asset manager. I bought it because the valuation was low and I thought that sentiment against asset managers was too negative.

I learned two lessons from this stock: (1) I should do more homework and (2) I shouldn’t mess around with asset managers because they are difficult to value.

If I did more homework, I would have seen that their assets under management were in a state of decline even when things were rosy for other asset managers and that their strategies underperformed all of their respective benchmarks.

I lost 51.56% on Manning & Napier.

United Insurance Holdings (UIHC) & Federated National Holdings (FNHC)

These weren’t mistakes because I bought them, they were mistakes because of the circumstances that I sold them. I purchased both Florida-based insurance companies because they were cheap in the wake of Hurricane Matthew and were well run.

I reacted emotionally when Hurricane Irma was barrelling towards Florida and sold both in a panic. If I just stayed put, it would have worked out fine. While they plunged substantially more after I sold them, they later recovered quickly from the depths of the decline and are now higher than when I sold them.

Lesson learned: don’t panic. Also, don’t buy more than 1 insurance company in Florida!

I lost 3.8% on UIHC and 23.36% on FNHC.

IDT Corp (IDT)

IDT was purchased because of the low P/E and low financial debt. Like CATO, IDT gave me an obvious warning sign that I was about to lose money: it posted an operating loss in the spring. I should have paid closer attention to the deterioration in fundamentals and exited the position.

My sale of IDT was pure luck. I exited on December 1st to begin my rebalance and was lucky enough to get out at one of the more attractive prices this year after the spring meltdown. I managed to exit losing 21.44%. A few days later, the stock plunged another 32%.

Lesson learned (same as CATO): when a company that you own posts an operating loss then it’s time to revisit the thesis.

US Market Valuations

We’re currently at a CAPE ratio of 32.56. Japan was around a similar valuation in 1985 when the Plaza accords were signed. Returns a decade out were predictably low, but that didn’t stop the Japanese market from stampeding to a CAPE of 100 by the end of the ‘80s. The same thing could happen to the US market. There is no way of knowing.

I don’t pretend to know what will happen in the upcoming year, but I do look at macro indicators to identify what we can expect over the long term (10 years from now) in the United States. I hope to earn a premium over the market return, but the market return will act as the force of gravity on my own gains. For that reason, I pay close attention to it.

My favorite metric of market valuation is the average investor allocation to equities. With the most recent data, that figure currently stands at 42.82%. Plugging this into my formula (Expected 10-year rate of return = (-.8 * Average Equity Allocation)+37.5), I get an expected 10-year return of 3.24%.


3.24% isn’t particularly exciting, but it’s not the end of the world either. It is a premium to the current 10-year yield, which is currently at 2.41%. The road to those returns is unknowable, but if history is any guide, it will not be 3.24% in a straight and orderly line. Within the next 10 years, there are going to be both screaming bull markets and savage bear markets. Through it all, a 3-4% return is the likely outcome.

Market returns are going to be low over the next decade, but not negative. Investors are likely to be disappointed in their future profits. With that said, it’s also not a Mad Max end of Western civilization scenario.

Recession Risk

As for the US economy, the current risk of a recession is low. If the market turns in 2018, I don’t think it will be driven by a recession or a problem brewing from within the economy. It may be caused by valuations just coming back to normal. In 2000, high flying stocks didn’t come back down to Earth because of a recession. People just realized that the prices were nuts. It just happened. Oddly, the decline in stocks likely caused the recession of 2001. Most of the time, this happens the other way around. Macro trouble brings stocks back down to Earth.

I think recession risk is low because the Federal Reserve is still accommodative and the balance sheets of households and businesses are still in good shape. Of course, wild things could happen like a war against North Korea or oil spiking to an insane level due to a revolution in Saudi Arabia. With that said, a recession is unlikely to occur naturally.

The Federal Reserve is both the cause and cure of nearly every U.S. recession, whether we like it or not. As they tighten monetary policy, they restrict cash flows for households and businesses. Ultimately, this causes households and businesses to limit spending, causing a recession. The Fed then loosens monetary policy until businesses and households begin borrowing and spending again. Cycle repeats.

A useful metric of the current household cash flow situation is household debt service payments as a percentage of disposable income.  Currently, this remains at a very low level of 9.91%. This implies that households are not going to restrict cash flows as a result of Fed tightening. Fed tightening isn’t having much of an impact (yet) because rates are low and most households cleaned up their balance sheets after the financial crisis. The same is true of the debt/equity ratio for the S&P 500. Firms haven’t gotten crazy with leverage in the current cycle after getting burned so badly last time.


Households aren’t stretched


Corporate leverage also looks healthy

The yield curve is another excellent indicator of the current state of monetary policy. The best metric to measure this is the difference between the 10 and 2-year treasury yield. It’s still positive, implying that the Fed still has more room to tighten rates without triggering a recession. In other words, monetary policy is still accommodative.


The yield curve has not yet inverted. Monetary policy is still accommodative.

With households and company cash flows in good shape (because of low leverage) and an accommodative monetary policy, the risk of a recession is very low.

My US macro view: (1) Returns are going to be low over the next 10 years because stocks are expensive, but equities will still return a premium over bonds. However, a 3.24% rate of return is significantly below the expectations of most investors.  (2) The risk of a recession is low because the current round of Fed tightening isn’t restrictive enough to cause businesses and firms to restrict their spending.

The 2018 Portfolio

For analysis of each company stock that I own, you can read my analysis here. A breakdown of my portfolio is below.


I currently own (1) a small piece of a net-net (Pendrell), (2) a spin-off at an attractive enterprise multiple (MSGN), (3) multiple companies in assorted industries with low valuations and safe balance sheets, (4) multiple retail stocks with low P/E’s and debt/equity ratios and (5) two very cheap airlines (Alaska & Hawaiian Air).

I also set aside 20% of my portfolio to put into country indexes with low Shiller P/E’s. I did this because it allowed for some international diversification in a manner consistent with a value framework and it reduces my exposure to retail. If I were to fill my portfolio with all the cheap stocks in the United States right now, my portfolio would be 60-80% in retail stocks. I decided to cap this at 30%. Currently, 28% of my portfolio is invested in the retail sector.

If these retail stocks are cut in half, I will lose 14% of my portfolio. That is a loss that I can deal with. If I were 60-80% in the retail sector, then a 50% drawdown in retail would take my portfolio down by 30-40%. That is a more difficult event to recover from.

In a value-oriented portfolio, you have to go where the bargains are. For the last couple of years that has been the retail sector and everyone knows why: Amazon. I think the retail sector is undervalued and that the current narrative is overblown. In 2018, we’ll see how that works out.

My concentration in the retail sector is not merely for the bargains, but also my belief that a recession is unlikely in the upcoming year. The economy is strong even though our markets are expensive and poised for disappointing gains in the future. If the yield curve were inverted and consumers looked stretched, I would have a different outlook.

My outlook for the US economy is also why I am comfortable investing in Kelly Services, a staffing company with low valuation metrics that will benefit from the tight labor market.

The full portfolio breakdown is below:


Of course, all of this is speculation. That is why the margin of safety is the paramount concern when I make a purchase. Even if I’m wrong, I at least purchased at an attractive valuation. I buy stocks that post multiple low valuation metrics: low P/E’s, low enterprise multiples, low price/sales. I also like stocks with little debt as measured by debt/equity and debt/EBITDA. This is very similar to the strategy outlined by Benjamin Graham in the 1970s. Even if I’m wrong about the US economy, I am systematically buying cheap stocks with clean balance sheets, which should perform well over the long run.

Investing vs. Speculation

Bull markets dull the senses. Years of high returns with few drawdowns make people forget what the pain of losing money is like. They become more confident. They become more greedy.

As value investors, one of our key responsibilities is to not get swept up in the mania. We have to keep our wits about us. One of the key things to keep in mind is the difference between investing and speculation.

Graham defined the difference as follows: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”

In other words, an investment is something for which you can calculate a margin of safety. Your margin of safety might be wrong. There are undoubtedly many ways to determine if you have a margin of safety. There are value investors who focus on assets. There are some who look at earnings based ratios. There are others who perform discounted cash flow analysis. Some take a relative valuation standpoint. Others try to purchase growth at a reasonable price.

“Value investing” is a big tent and there isn’t one right approach or one true faith, but the important concept is: value investors are trying to figure out what something is worth and they are trying to pay less for it. They might be wrong in their analysis, but at least there is logic to it.

Speculation, in contrast, is when you can’t calculate a margin of safety and buy it anyway. Speculation is looking at a chart. Speculation is looking at recent price action and getting excited about it. Speculation is listening to a hot stock tip and buying it without doing any homework on your own. Speculation is buying something for which you can’t calculate a margin of safety and don’t understand.

With that said, you can’t be a speculator and a value investor at the same time. A value investor is a person for whom the margin of safety is the paramount concern in investing. Value investing isn’t a series of techniques and statistical abstractions: it is a way of thinking about the world.

The 21st-century term for speculation is FOMO. Fear of missing out. For a value investor, that’s the emotion that we need to continually keep in check and resist. Resisting FOMO may keep us out of “multi-baggers,” “compounders.” Investing is methodical and boring. Speculation is exciting. It may make us describe our returns in percentages and not “x.” It will also keep us from suffering permanent losses of capital. You can’t compound from zero.

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A reminder from Highlander: avoid permanent losses of capital.

One of the peculiar things about value investing is that the secret has been out since Benjamin Graham wrote “Security Analysis” in 1934. You would think that value investing would have been arbitraged away by now. You would think that it would be in the dustbin of history. The reason that hasn’t happened is because value investing goes against human nature. Most people are speculators. They are enticed by price action, they feel FOMO. People are never going to change, and that’s why Benjamin Graham’s lessons are timeless.

Only a select few are immune to this impulse. They’re the kind of people who look at a mania and think “this is BS.” They’re the kind of people who get excited when they buy a $50 pair of shoes for $25. They’re people who don’t look at value investing as some kind of statistical trick or academic exercise: it’s in their blood. It’s a way of thinking about the world. It’s a way of thinking that runs contrary to much of human nature. That’s why it continues to endure.

Before you make a purchase, think about it through this lens. Am I buying something for which I can calculate a margin of safety? Do I have a margin of safety? If the answer to both questions is “no” then you’re speculating, not investing.

There are certainly wealthy speculators, but they’re the exception. Speculation doesn’t work out too well for most of us. Speculation is buying something based on a chart, based on hype, based on a story. Success in investing requires us to avoid these impulses entirely.

Value investing isn’t low P/E, low price/sales, the magic formula, net current asset value, or low EV/EBIT. Value investing is a way of looking at the world rationally and not allowing ourselves to be swept up in the emotional impulse to speculate. This is an important thing to keep in mind in these frothy, speculative times.

The Blog

The year wasn’t entirely filled with folly. Concerning achievements, I’m most proud that I finally took the plunge and started this blog.

I’ve struggled with the itch to pursue active value investing for most of my adult life and lacked either the money or the courage to do so. The blog has been a real-time chronicle of my journey as a value investor. It also helps me stay accountable.

This year, I think my biggest achievement was finally pulling the trigger and doing this after thinking about it for so long.

Looking back at my posts, I am happy I did this. It is nice to look back and see my views in real time. It’s fun to share what I’m reading and thinking with others.

The blog is useful. It’s comfortable with the benefit of hindsight to look back and try to frame what I thought in the past. Putting down my thoughts on a blog makes it impossible to do that. It makes me more accountable for my decisions. I can look back and see why I did something and what my thought process was at the time. Hopefully, I can stick to it. I think it will help me become a better investor. I encourage others to do the same thing. Even if you don’t do it publicly, keep a journal and keep track of your decisions. Revisiting those decisions and your process will help improve your skills as an investor in the future.

I appreciate all of the feedback and am somewhat surprised that I actually have readers! Hopefully, you can all learn from my mistakes and goofs. Keep reading: you can learn about the markets on my dime!

To all of you, have a very happy, healthy and prosperous New Year!

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Aflac (AFL)


Key Statistics

Enterprise Value = $33.806 billion

Operating Income = $4.586 billion

EV/Operating Income = 7.37x

Earnings Yield = 8%

Price/Revenue = 1.56x

Debt/Equity = 24%

The Company

Aflac is an insurance company based in Georgia with a wide presence in the United States and Japan. Aflac underwrites a range of insurance products such as: life, cancer, vision and dental insurance.


Aflac is not a hated stock. In the last year, the stock is up almost 25% and it participated in the S&P’s rally.  Despite this, the valuation multiples are still low and it is one of the cheapest stocks in the S&P 500 universe.

My Take

Aflac is certainly not the typical kind of company that I buy. There aren’t any glaring problems. I am usually on the hunt for deeply depressed and despised bargain stocks. Aflac is still a bargain, but it’s not something that the market hates. In the current environment, screaming bargains are not easily found.

I’m interested in Aflac from a relative valuation standpoint. Aflac currently trades at a P/E of 12.72. Compare this to the P/E multiples of other insurance companies: Progressive (23.43), Allstate (14.46), Travelers (15.53). Aflac could easily rise to a P/E multiple of 15-20 in the next year.

Aflac is also posting better returns than other insurance companies. Aflac’s return on equity is 13.93%. Compare this to other insurance firms: Progressive (13.52%), Allstate (9.49%), Travelers (12.78%). Aflac is also achieving this ROE result with very little leverage, with a debt/equity ratio of only 24%.

Aflac won’t offer exciting returns (it doesn’t have the potential for massive appreciation like Francesca’s, Big 5, or Foot Locker), but I think it is a safe place to deploy some of my funds in a manner that should outperform the S&P 500 over the next year. It also pays a high dividend yield of 2% (well, high for the S&P 500 universe). In addition to the 2% dividend, they are also buying back shares at a high rate. The common share count has been reduced by 3.47% in the last year.  In the last 4 years, they have bought back 14.19% of the common stock.

The enterprise multiple of 7.37 also makes it one of the cheapest stocks in the S&P 500. Some might object to my use of enterprise multiple and price/revenue in my valuation, but I think it makes sense for insurance companies. Insurance companies are really a product of their premiums (revenues), so I think it makes perfect sense to evaluate them based on an enterprise multiple. The balance sheet aspect of enterprise values is also particularly important for insurance companies, as debt relative to cash and assets is a good rough measure of the risks that the insurance company is taking.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Dick’s Sporting Goods (DKS)


Key Statistics

Enterprise Value = $3.505 billion

Operating Income = $461.74 million

EV/Operating Income = 7.59x

Earnings Yield = 9%

Price/Revenue = .69x

Debt/Equity = 28%

Debt/EBITDA = .71x

The Company

Dick’s Sporting Goods is a large sporting goods retailer. They operate 797 stores in the continental United States. In addition to the primary Dick’s stores, they also own Field and Stream and Golf Galaxy.


The stock is currently despised by the market, down 47.9% in the last year. Dick’s is undergoing the same pressures that are affecting all retail players. In the last year, same-store sales have declined and margins have been under pressure.

My Take

Dick’s Sporting Goods is currently priced for oblivion. Usually, when you see a company this cheap, there should be absolutely terrible news emerging from the stock.

In the case of Dick’s, the news hasn’t even been that bad when compared to the reaction in the market. The bad news has been pretty tame: in the last quarter, the company made 35 cents a share compared to 44 cents a year ago. This hardly seems like a case for Armageddon. Earnings were down because margins are under pressure.

While they have many physical retail locations, they also have a decent e-commerce platform. 12% of their sales occur online. In fact, e-commerce sales increased by 16% in the most recent quarter, helping increase their total sales from a year ago.

A nice and growing e-commerce platform, increasing sales, not a mall anchor, not totally concentrated in apparel. It looks to me like Dick’s Sporting Goods is actually one of the better companies in the retail sector and it is priced like it is one of the worst.

The company has very low debt levels in comparison to its assets and earnings and is steadily producing free cash flow, even outside of the holiday season. Most importantly, they are returning capital to shareholders. Common shares have declined by 5.7% in the last year and the stock currently boasts a 2.29% dividend yield. In the last five years, common shares have declined by 13%.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Tredegar (TG)

Tredegar Corp (TG)

Key Statistics

Enterprise Value = $787.53 million

Operating Income = $42.47 million

EV/Operating Income = 18x

Price/Revenue = .7x

Earnings Yield = 9%

Debt/Equity = 47%

Debt/EBITDA = 2.21x

The Company

Tredegar is a manufacturer of polyethylene plastic films, polyester films, and aluminum extrusions. Aluminum extrusions are used in the construction and automotive sectors, so they benefit directly when the economy is expanding and are highly cyclical.  The plastic films are used mainly for hygiene products like diapers and feminine products.


The market is largely indifferent to this company.  Since the early 2000s, the stock has been stuck in a trading range between $13 and peaking around $25-$30. The price is currently at $18.90 and is down 21.25% YTD. Revenues and operating income have been in decline since 2013, which have contributed to the downward pressure in the stock price.

My take

One of the main strengths of the company is that it is has a large insider ownership, currently at 22%. This creates strong incentives to steady the course of the company.  On the negative side, the aluminum extrusion business is prone to the cyclicality of the US economy. In other words, a recession would seriously hurt this company.  Also on the negative side, the business of plastic films is also highly dependent on purchases from Procter & Gamble, who decided a year ago to diversify their supplier base and this hurt Tredegar’s sales.  Hopefully, the company will find new sources of sales and P&G won’t cut anymore.

On an EV/EBIT basis, the stock looks expensive, but it still has an attractive earnings yield and is cheap on a price/sales basis.  Much of the high EV/EBIT valuation is due to the fact that operating income has been diminished by the loss of revenue to Procter & Gamble and the fact that the company has a low cash stockpile. With that said, the overall debt/equity and debt/EBITDA ratios are relatively low.

I’m encouraged that the company is making efforts to cut costs by moving more domestic manufacturing to its Lake Zurich, IL facility.  I also believe the aluminum extrusion business will continue to expand, as a recession appears to be unlikely in the upcoming year.  Possible catalysts that could move the stock higher include: (1) the cost-cutting measures that have been depressing earnings start paying off, or (2) more customers are found outside of Procter & Gamble.  The high level of insider ownership implies to me that management will likely push hard for measures to turn the firm around.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Interdigital (IDCC)


Interdigital (IDCC)

Key Statistics

Enterprise Value = $2.007 billion

Operating Income = $365.34 million

EV/Operating Income = 5.49x

Price/Revenue = 4.54x

Earnings Yield = 9%

Debt/Equity = 34%

Debt/EBITDA = .68x

The Company

Interdigital develops technology patents (they currently have over 20,000 of them), primarily for the wireless industry. They make their money by licensing this technology to other companies. They license tech used for all of the big wireless companies, including Apple and Samsung. IDCC also derives revenue from lawsuits when other firms violate those patents.


Over the long term, IDCC has performed well. Wireless is a global growth industry and they own some of the critical technology that makes it possible. In the last 10 years, the stock is up 268%, beating the S&P’s 79% return by a wide margin. However, the stock is extremely volatile and prone to big swings in price. In the last year, the stock is down 8.96%. The relatively bad stock performance despite this being in a growth industry are due to earnings volatility, which can be driven by swings in the outcome of litigation.

My Take

IDCC is ignored by the market because of its size and earnings volatility compared to tech giants. The patents generate a significant amount of free cash flow, giving the stock a free cash flow yield of 10.49%. The ample free cash flow enables IDCC to remain a player without having to accrue significant debt levels.

On an absolute basis, the stock is cheap, but it’s also cheap on a relative basis. If IDCC were an S&P 500 component, it would probably trade at a significantly higher valuation.  A similar company like Qualcomm, who also develops wireless technology and leases patents, trades at a P/E multiple of 38.85. On “quality” metrics, IDCC is actually posting better returns on assets than Qualcomm. IDCC’s gross profit/assets are 21.78%, compared to Qualcomm’s 19%.

My only explanation for the discrepancy in price and quality is due to IDCC’s smaller market capitalization and choppy earnings results. If IDCC were an S&P 500 component, I think it would be valued a lot differently by the market, probably at a P/E of 30x or 40x.

IDCC is also not resting on its laurels. They continue to aggressively spend on research & development of new patent technology, averaging around $60-$70 million a year (19% of its operating income). They have close relationships with the wireless device manufacturers, so it is unlikely that competitors will enter their space and compete.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

MSG Networks (MSGN)


Key Statistics

Enterprise Value = $2.607 billion

Operating Income = $314.7 million

EV/Operating Income = 8.28x

Earnings Yield = 11%

Price/Revenue = 2.20x

Debt/Assets = 157%

Debt/EBITDA = 3.98x

The Company

MSG Networks is a product of a spin-off from Madison Square Gardens which occurred in 2015. The company represents the cable division, broadcasting events that occur in Madison Square Gardens. Cable networks pay MSGN fees for their content. The content includes NY sports teas like the Rangers, Knicks, Islanders, Devils. The stock is controlled by the Dolan family.


Sentiment against the cable industry and MSGN are negative. Everyone is worried about cord cutters. As cord-cutting catches on, content delivered on cable TV will become less valuable. As it becomes less valuable, cable channels will receive less revenue for the content that they distribute. When MSGN was spun off, it was also saddled with a massive amount of debt from the parent company, which is a risk.

My Take

While the market is worried about cord cutting, MSGN has a robust business that is throwing off generous amounts of free cash flow. They have been using the free cash flow to pay off debt that they were saddled with in the spin-off, thus improving their enterprise multiple valuation. They also announced a massive share buyback program recently for $150 million. That represents 10% of the existing market capitalization.

Even if cord cutting is a problem, I find it difficult to imagine a scenario where people don’t watch New York sports. Even if cord cutting catches on, it seems unlikely that MSGN’s properties won’t be valuable.

The debt is a problem. I usually avoid leverage whenever possible, but it is difficult to find spin-offs that aren’t significantly leveraged. Leverage, unfortunately, goes with the territory. When a parent unloads a smaller spin-off, they frequently use it as an opportunity to unload their debt onto the smaller firm. This is a major reason that spin-offs are neglected by the market as a whole.

Even with the debt, MSGN should continue to throw off cash flow that will service it. They are also taking the debt seriously and paying it down, thereby improving their enterprise valuation.

The cable industry is also in a state of consolidation. Disney recently purchased a significant portion of Fox. Starz was also bought out last year. MSGN is an attractive buyout candidate at its current valuation. In fact, selling the company may have been one of the reasons this was spun off in the first place: to isolate the cable entity for a potential acquirer.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

Big Five Sporting Goods (BGFV)


Key Statistics

Enterprise Value = $204.78 million

Operating Income = $36.44 million

EV/Operating Income = 5.59x

Earnings Yield = 14%

Price/Revenue = .15x

Debt/Equity = 25%

Debt/EBITDA = .91x

The Company

Big 5 Sporting Goods is a sporting goods retailer. They operate primarily on the West coast. In addition to their physical stores, they also have an electronic presence. The original location was built in California by Robert Miller. It started in 1955 selling World War II surplus items. They have grown to 432 locations and the typical store is roughly 11,000 square feet.  Their focus is on limiting prices. They purchase brand-name merchandise but acquire inventory via over-stock and close-outs, ensuring they can obtain the inventory at the cheapest prices available.


The market utterly despises this stock. Year to date it is down 57.64%. The stock now trades below book value of $9.48 per share and boasts an absurdly high dividend yield of 8.16%. The stock price is now down near lows experienced during the Great Recession.

My Take

Big 5 is the kind of stock I love: its an absurdly cheap stock in which investors appear to have thrown the baby out with the bathwater. In the most recent quarter, revenue fell 3.2% and operating income fell 25%. Angels and ministers of grace defend us!

Big 5 isn’t producing impressive results, but it’s not a collapse either, which is how it is currently priced. The current Amazon-driven retailpocalypse is making investors throw away small retailers like Big 5 with abandon.

I don’t normally chase dividends, but the stock pays a healthy dividend of 8.16%, which should far surpass what the S&P 500 will deliver long-term. Free cash flow ($27.56 MM over the last twelve months) is robust enough to support the dividend. If Big 5 can deliver on a decent holiday season, I hope I can get a return through multiple appreciation. A movement in the stock from the current 7.35 P/E to a still-depressed 10 would be a 36% return. The 8% dividend yield isn’t something I typically chase, but it is nice to be paid while I wait.

The small size is also attractive. In the ‘90s, the company was taken private and was bought out by management. At such an absurd valuation, I don’t see why the same thing couldn’t happen again if the market continues to look at the stock with such intense hatred.

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.

I am a value investor. My outlook is inspired by the ideas of Benjamin Graham. This site is a real time chronicle of my portfolio and an outlet to share my ideas. I hope you enjoy.