Book Review: You Can
be a Stock Market Genius: Chapter 1 – 2
Here is a review
of Greenblatt’s classic book that focuses on the basic investing tenants covered in the
first two chapters. These investing insights have become basic to my whole investing
approach and echo what I have always intuited…despite what the financial industry/academia
say, volatility is not risk…it is noise.
In the opening chapter, Greenblatt explains how the ordinary
investor has a chance against all the portfolio managers who dominate the
market.
For one thing, many of the well-educated MBA-types subscribe to the Efficient Market Hypothesis, which makes them measure risk in an absurd way according to value investors. Price volatility is considered the best measure for risk for these market participants, and since value investors evaluate risk upon better measures (e.g. risk of bankruptcy, revenue risk etc.), opportunities are out there.
Second, institutional managers have a much smaller domain in which to invest. A billion-dollar fund can only buy positions in billion-dollar companies, or else the positions will either be so small that they will not affect returns, or the position sizes would be large and market-moving. Ordinary investors, on the other hand, have thousands more stocks to choose from, increasing the chances of finding a diamond in the rough.
In order to benefit from these advantages, ordinary investors have to look in places that no one else does, since the opportunities available to them will not be publicized. Greenblatt compares this kind of investing to antique shopping for bargains. Antique shoppers that have some knowledge of the market for certain objects can often find bargains in out-of-the-way places where others of their ilk aren't competing with them. Greenblatt argues that small investors must employ a similar strategy, and this book is dedicated to illustrating how.
Chapter 2.
Greenblatt discusses some requirements that investors must follow if they plan to outperform in the market. First, they need to do their own work. The opportunities offering the best rewards will not be covered by the media or Wall Street. Investors must also not take advice from others, including brokers and analysts. These advisers are paid based on how much they generate in business for their firms, and not by how well you do.
Greenblatt also argues against too much diversification. For one thing, he cites research suggesting that as the number of stocks in the portfolio increases, the benefits of diversification drop quickly. For example, he argues that the diversification benefit between owning eight stocks and owning five hundred stocks isn't that large; but the benefit of owning eight stocks is that you can really pick your spots in terms of choosing stocks with potential upside that is higher than the potential downside. A better method of diversifying, Greenblatt argues, involves keeping some money out of the stock market (e.g. in cash, bonds, home equity etc.).
Greenblatt also advises that investors avoid looking at an investment in terms of its upside potential. Instead, look at the downside, and employ a margin of safety with all purchases. If you look after the downside, the upside usually takes care of itself.
Finally, Greenblatt discusses the fact that there are many ways to make money in the stock market. Every investor cannot possibly participate in even a fraction of the opportunities that are out there. Furthermore, there are many different methods by which investors can be successful. For example, Ben Graham used a quantitative, statistical approach, whereas Warren Buffett identifies and exploits competitive advantages. Greenblatt goes through a number of situations in the following pages that demonstrate the ways in which enterprising investors can profit from the market.
For one thing, many of the well-educated MBA-types subscribe to the Efficient Market Hypothesis, which makes them measure risk in an absurd way according to value investors. Price volatility is considered the best measure for risk for these market participants, and since value investors evaluate risk upon better measures (e.g. risk of bankruptcy, revenue risk etc.), opportunities are out there.
Second, institutional managers have a much smaller domain in which to invest. A billion-dollar fund can only buy positions in billion-dollar companies, or else the positions will either be so small that they will not affect returns, or the position sizes would be large and market-moving. Ordinary investors, on the other hand, have thousands more stocks to choose from, increasing the chances of finding a diamond in the rough.
In order to benefit from these advantages, ordinary investors have to look in places that no one else does, since the opportunities available to them will not be publicized. Greenblatt compares this kind of investing to antique shopping for bargains. Antique shoppers that have some knowledge of the market for certain objects can often find bargains in out-of-the-way places where others of their ilk aren't competing with them. Greenblatt argues that small investors must employ a similar strategy, and this book is dedicated to illustrating how.
Chapter 2.
Greenblatt discusses some requirements that investors must follow if they plan to outperform in the market. First, they need to do their own work. The opportunities offering the best rewards will not be covered by the media or Wall Street. Investors must also not take advice from others, including brokers and analysts. These advisers are paid based on how much they generate in business for their firms, and not by how well you do.
Greenblatt also argues against too much diversification. For one thing, he cites research suggesting that as the number of stocks in the portfolio increases, the benefits of diversification drop quickly. For example, he argues that the diversification benefit between owning eight stocks and owning five hundred stocks isn't that large; but the benefit of owning eight stocks is that you can really pick your spots in terms of choosing stocks with potential upside that is higher than the potential downside. A better method of diversifying, Greenblatt argues, involves keeping some money out of the stock market (e.g. in cash, bonds, home equity etc.).
Greenblatt also advises that investors avoid looking at an investment in terms of its upside potential. Instead, look at the downside, and employ a margin of safety with all purchases. If you look after the downside, the upside usually takes care of itself.
Finally, Greenblatt discusses the fact that there are many ways to make money in the stock market. Every investor cannot possibly participate in even a fraction of the opportunities that are out there. Furthermore, there are many different methods by which investors can be successful. For example, Ben Graham used a quantitative, statistical approach, whereas Warren Buffett identifies and exploits competitive advantages. Greenblatt goes through a number of situations in the following pages that demonstrate the ways in which enterprising investors can profit from the market.
Resources,
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