Fluenteers, welcome back! And a special salute to the Fluent Few — our inner circle of long-term compounders and partners. 👋🏻
Joel Greenblatt is best known for compounding capital at extraordinary rates, around 40% a year over two decades, by doing something that sounds almost boring:
Treating stocks as ownership in real businesses
Valuing those businesses carefully
Buying them when they are cheap
Then, waiting patiently for the market to catch up
No macro forecasts. No guessing what the Fed will do. No obsession with daily news.
This article outlines his core ideas on why active investing can still work, how to value businesses in practice, and why patience is the real “edge” in markets dominated by short-term thinking.
The Market’s “Second Guess”: Jelly Beans and Stock Prices
Greenblatt once tried to explain how markets behave to a 9th-grade class.
He brought in a jar of jelly beans and did two rounds of guessing:
Round 1 – private guesses (the “cold” guess)
Every student got a 3×5 card.
They examined the jar, counted rows, and wrote down their own best estimate.
The average of these private guesses was 1,771.
The true number of jelly beans was 1,776.
The crowd, thinking independently, was almost perfectly right.
Round 2 – public guesses (the “market” guess)
Greenblatt then went around the room and asked each student out loud, one by one, “What’s your guess now?”
Everyone had heard the earlier discussion, reactions, and comments.
The new average was about 850, way off.
His point:
The first average (1,771) is like a rational appraisal of value.
The second average (850) is like the stock market: influenced by what everyone else just said, by the news, by emotion, and noise.
The “second guess” can be wildly wrong in the short term. That is where the opportunity lies for disciplined investors.
“Isn’t the Party Over?” – Why Opportunities Still Exist
In his Columbia value investing class, Greenblatt says he gets a version of this question every year:
“With all the computers, data, hedge funds, and quants…isn’t the party over? Isn’t the market too efficient now?”
His answer is to look at what has happened in the most followed market in the world,the U.S.,and within the most followed stocks in that market, the S&P 500, since his students learned to read.
Roughly:
1997–2000: S&P 500 doubled
2000–2002: S&P 500 halved
2002–2007: S&P 500 doubled
2007–2009: S&P 500 halved
2009–today (at the time he spoke): roughly tripled
That is with an index of 500 companies smoothing the ride.
Underneath that average, individual stocks move far more wildly: some are in extreme favor, others extremely out of favor at any point in time.
His conclusion:
“People are still crazy.”
Human behaviour hasn’t changed.
Fear, greed, fashion, and herd mentality still dominate prices in the short run. That is why mispricings persist, especially within the index, between cheap, overlooked businesses and glamorous, overhyped ones.
Stocks Are Not “Pieces of Paper”
Greenblatt makes one promise to his students:
If you do good valuation work on a business, the market will agree with you.
He just never tells them when.
That is crucial. Stocks aren’t pieces of paper with ratios attached. They are ownership shares of businesses.
If you:
Understand the business
Estimate what it’s worth with reasonable assumptions
And buy at a meaningful discount
…then, over time, as the business reports earnings, generates cash, and compounds value, the market tends to move its “second guess” toward reality.
The catch is timing. It might take:
A few weeks
A year
Two or three years
But if your valuation is sound, you’re betting on economics, not opinion.
This is the Ben Graham picture Greenblatt uses:
A horizontal line: fair value of the business
A wavy line around it: the stock price over time
If you have a disciplined process to:
Buy more when the price is below fair value
Sell or short when the price is above fair value
…the market, with all its noise, is constantly “throwing pitches” you can choose to swing at or ignore.
How Greenblatt Thinks About Valuation: The House Analogy
Most people find real estate easier to think about than stocks.
So Greenblatt frames valuation like buying a house.
Suppose someone is asking $1,000,000 for a house. Is that a good deal?
You’d probably start with two simple questions:
What rent could I get?
If you can rent it out for $70–90k a year, that’s a 7–9% yield.
That gives you a sense of absolute cheapness: “What cash return do I get on my purchase price?”
How does it compare to other houses?
What are other similar houses on the block selling for?
What about the next street or the next town?
Is this house cheap relative to alternatives?
That is exactly how he approaches stocks:
Absolute value:
How much “rent” (earnings / free cash flow) do I get for the “purchase price” (enterprise value/market cap)?Relative value:
How cheap is this business versus similar businesses and versus the wider opportunity set?History:
How has this business traditionally been valued? Is it cheaper now than usual relative to its own history and peers?
He combines several measures of absolute and relative value as checks and balances to triangulate fair value. No single metric is perfect on its own.
For example:
Only using relative value can fool you (e.g., buying the “cheapest” internet stock in 1999, cheap relative to other bubbles is still expensive in reality).
Only using a simple yield can miss structural issues.
The point is not precision to the last decimal. It is to get comfortably in the right ballpark of value.
Does Buying Cheap Actually Work? The 20-Year Study
Greenblatt and his team ran a simple study:
Universe: the 2,000 largest U.S. companies
Period: 1992–2012 (20 years)
Every day, they:
Estimated value for each company using their absolute/relative framework
Ranked all 2,000 stocks from cheapest (biggest discount to value) to most expensive
They then grouped the stocks into percentiles and looked at the average 1-year forward returns from each bucket over the 20 years.
Results (conceptually):
1st percentile (cheapest 20 stocks)
→ ~38% average 1-year forward return2nd percentile
→ ~37% average 1-year forward returnAs you move toward more expensive stocks, average returns decline.
The most expensive bucket sits at the bottom of the chart with the lowest subsequent returns.
If you were in his Columbia class and he asked, “What long/short strategy would you run here?” the obvious answer is:
Buy the very cheap bucket in the upper left
Short the very expensive bucket in the lower right
That is essentially what he does.
Two critical caveats:
This is a 20-year average.
It looks smooth and “obvious” in hindsight. Living through it is nothing like that.Over shorter windows, 3 or 4 years, the relationship is much noisier.
The “fit” might drop from something like 0.9 (very strong) to 0.5–0.6.
In plain English, there are extended stretches where being cheap does not win.
If this worked every day, month, and year, everyone would do it, and the edge would disappear. The reason it persists is precisely that it doesn’t work on a timetable convenient for most people.
Why He Sticks With Value Even When It Hurts
Many documented factors have worked historically, including momentum (buying what has been going up).
Momentum, Greenblatt notes, has:
Worked in many markets
Worked over multiple decades
Been heavily studied and exploited
But here is the problem:
If momentum stopped working for 2–3 years, you would face an uncomfortable question:
Is this just a normal cycle, and I should be patient?
Or has the edge been arbitraged away by computers, quants, and crowding?
You would not know which.
With value as “ownership in a business at a discount”, the logic is different:
If good businesses at low prices underperform for a few years, the explanation is not “the idea of value stopped making sense”.
It is simply that the market is mispricing them for longer than usual.
Greenblatt’s response in that scenario is:
He is not going to pivot and start buying money-losing companies
He is not going to pay 100× free cash flow for fragile businesses just because they are working right now
He will continue to buy high-quality companies at attractive rents (earnings yields) and wait
The earlier valuation study is his true north.
It indicates that, on average, his company valuations align with market valuations over time. He is willing to endure periods where price and value diverge because he trusts the economics, not recent price action.
Why Simple Value Signals Don’t Get Arbitraged Away
If there is such a clear link between cheapness and future returns, why doesn’t arbitrage erase it?
Greenblatt uses a gold example:
Suppose today gold trades at $1,200 in New York and $1,201 in London.
A trader on a desk can:
Buy in New York
Sell in London
Capture the small spread
Push prices together almost instantly
That is classic riskless arbitrage.
Now change the problem:
You can buy gold in New York today at $1,200
You are told that sometime in the next 2–3 years, you will probably make money
But you might be down 20% at some point while you wait
There is no one on a trading desk who can arbitrage that away in the same sense:
The timing is uncertain
The mark-to-market pain in between is real
Clients, risk managers, and careers often cannot tolerate it
This is exactly the nature of value investing. You get:
A good probabilistic payoff over a multi-year horizon
At the cost of painful interim volatility
On top of that, time horizons in markets are shrinking:
Investors used to get quarterly paper statements and often ignored them
Now you can check stock prices on your phone dozens of times a day
More frequent feedback encourages shorter time horizons and more reactive behaviour
Greenblatt’s edge is simply time arbitrage:
Being willing to own good, cheap businesses and wait 2–3 years for the market to agree, while others demand gratification in 2–3 weeks or 2–3 quarters.
Putting It All Together
Joel Greenblatt’s long-run record, about 40% annualised over many years, is not built on prediction, complexity, or speed. It is built on a few simple, hard disciplines:
View stocks as businesses, not tickers.
You are buying claims on future cash flows, not lottery tickets.Value those businesses realistically.
Use common-sense tools: “What rent do I earn on the price I pay?” and “How does this compare to alternatives and to its own history?”Buy at a discount.
Focus on companies that are both absolutely and relatively cheap on sound metrics, not just “less expensive than other overpriced things.”Accept that price and value can diverge for years.
The market is a noisy “second guess”, heavily influenced by crowd psychology.Exploit time horizons.
Take advantage of the fact that most investors cannot or will not sit through periods of underperformance, even when the underlying businesses are strong and cheap.
Index funds are a perfectly sensible choice for most people. Greenblatt agrees with Warren Buffett on that.
But for those willing to do valuation work and, more importantly, to be patient when it is uncomfortable, there is still plenty of room to outperform.
The “party” is not over. It just requires playing a different game: one measured in years, not days.
That’s it for today!
Thank you for reading and being part of this growing community of thoughtful, quality investors.
FluentInQuality exists to help you cut through the noise and focus on what truly compounds over time…
Quality, patience, and discipline.
If you enjoyed this piece, share it with someone who values long-term investing as much as you do.
Together, we grow smarter.
You can also connect with me across all platforms, where I share shorter insights, portfolio updates, and market lessons:
And remember: Great investments don’t shout. They compound quietly.
— Yorrin (FluentInQuality)
His free Magic formula screener has introduced me to so many successful investments over the years.
Joel Greenblatt magic formula sorting methodology :
E/P × ROIC
or
P/E ÷ ROIC