SPEAKER: Joel Greenblatt, our guest for today,

is the co-founder, managing principal,

and co-CIO of Gotham Asset Management.

We could not be more thrilled and more grateful

than to have him accept our invitation and be here.

Thank you so much, Joel-- over to you.

[APPLAUSE]

JOEL GREENBLATT: Thanks so much.

Thanks for coming out today.

I really appreciate it very much.

I've never been here before, so I'm looking forward to my tour

right after, so thank you.

So even Warren Buffett says the vast majority of people

should index, and I agree with him.

So are there any questions, or do I have any time?

[LAUGHTER]

Then again-- well, I have time, so then again, Warren Buffett

doesn't index and neither do I. So I thought I'd tell you why,

and then maybe you'll have some more information

to decide for yourself what makes sense for you.

And in a sense, it shouldn't be that hard.

Actually, I had a friend who's an orthopedic surgeon

and is in charge of a group of orthopedic surgeons.

And he asked me to speak to them at a dinner,

about the stock market.

And I said, OK, these are smart, educated guys.

They can understand this stuff.

And I spoke for about 35 minutes,

explaining how the stock market worked and everything else.

And then I started getting questions along the lines of,

oil went down $2 yesterday--

What should I do?

Or a market was up 2% yesterday--

what do I do about that?

So my interpretation of those questions

was I had just crashed and burned.

So last year, I was lucky enough to be

asked to teach a ninth-grade class, a bunch of kids,

mostly from Harlem.

And I had just sort of crashed and

burned with the orthopedic surgeons,

and I didn't want to do that with the kids.

And so I started to try to think of,

what could I do to explain the stock

market a little bit better?

And so I walked into class the first day,

and I handed out a bunch of three-by-five cards.

And I brought in this jar of jellybeans right here,

and I asked--

the students passed around the jar of jellybeans.

I asked them to count the rows, do whatever they wanted to do,

and write down their best guess for how many jellybeans

were in the jar.

I collected the three-by-five cards,

then I went around the room, one by one,

to each one of the kids in the room.

And I said, listen, you can keep your guess

or you can change your guess.

That's up to you.

And I went, one by one, around the room

and asked people how many, and wrote down the various guesses.

So it turned out, the average of the guesses

for the three-by-five cards was 1,771 jellybeans.

There are 1,776 jellybeans in the jar,

so that was pretty good.

The guess when I went around the room, that was 850 jellybeans.

And I explained to them that the stock market's actually

second-guessed, because everyone knows what they just

read in the paper or what the guy next to them said,

what they saw in the news, and are influenced

by everything around them.

And that was the second guess, and that's the stock market.

The cold, calculating guess, when

they were counting rows and trying

to figure out what was going on, that

actually was the better guess--

that's not the stock market.

But that's where I see our opportunity.

Once a year in my class at Columbia, at least

for the last five, six years, somebody raises their hand

and asks a question that goes something like this--

hey, Joel, congratulations.

You've been doing this for 35 years,

and you've had a nice record.

But now there are more computers, there's more data,

there's more ability to crunch numbers.

And isn't the party over for us?

Isn't it just more hedge funds?

It's just a lot more competition.

Isn't the party over for us?

So my students are generally second-year MBAs--

I'd say average age, 27 or so.

So I just answer it this way.

I tell them, let's go back to when you learned how to read.

Let's take a look at the most followed market in the world.

That would be the United States.

Let's take a look at the most followed stocks

within the most followed market in the world.

Those would be the S&P 500 stocks.

Let's take a look at what's happened

since you learned how to read.

So I tell them, from 1997--

when they were 9 or 10--

to 2000, the S&P 500 doubled.

From 2000 to 2002, it halved.

From 2002 to 2007, it doubled.

From 2007 to 2009, it halved.

And from 2009 to today, it's roughly tripled,

which is my way of telling them that people are still crazy.

That was just the last 17 years.

And I'm way understating the case,

because the S&P 500 is an average of 500 stocks.

If you lift up the covers and look underneath what's

going on, there's huge dispersion

of those 500 stocks between those,

at any particular time, that are in favor and those

that are out of favor.

And so there's a wild ride going on underneath the covers.

If you look under the covers, there's

a wild ride of those 500 stocks at any particular time.

And that doubling and halving, doubling

and halving with the average of 500 stocks

is really smoothing the ride.

So there should be an opportunity.

And if you understand what stocks are--

and I guarantee my students, first day of class--

I make a guarantee every year.

And they walk in, and I guarantee them

this-- if they do good valuation work of a company,

I guarantee them the market will agree with them.

I just never tell them when.

It could be a couple weeks.

It could be two or three years.

But if they do good valuation work,

the market will agree with them.

Stocks are not pieces of paper that bounce up and down,

and you put complicated ratios on,

like Sharpe ratios or Sortino ratios.

Stocks are ownership shares of businesses

that you are valuing and, if so inclined,

tried to buy at a discount.

So if you believe what Ben Graham said,

that this horizontal line is fair value,

and this wavy line around that horizontal line

are stock prices, and you have a disciplined process

to buy, perhaps, more than your fair share when they're

below the line, and, if so inclined, sell

or short more than your fair share

when they're above the line, the market

is throwing us pitches all of the time.

The reason people don't outperform the market--

there are behavioral problem.

There are agency problems.

But it's not because we're not getting those opportunities.

I will show you briefly--

let me tell you how we value stocks.

It's not very tough, and I think most of you will understand it.

And I think the best example that

seems to resonate with most people

is thinking about buying a house.

And to keep the numbers simple, let's

say that someone is asking $1 million for the house.

They want to sell, and your job is

to figure out whether that's a good deal or not.

So there's certain questions you would ask.

One of the first questions I'd ask

is, well, how much rent could I get for that thing, OK?

So in other words, if I rented out that million-dollar house,

how much rent would I collect?

If I were going to collect $70,000, $80,000,

$90,000 a year--

7%, 8%, 9% yield on that house--

that's one way I might go about valuing it.

And what's the next question you would ask?

I'm pretty sure I know what it would be.

What are the other houses on the block going for,

on the block next door and the town next door?

How does this compare?

How relatively cheap is this, relative to all

my current choices?

So that's what we do.

We look at, how relatively cheap is

this business, relative to other similar businesses,

relative to a whole universe of choices that I have?

We do that.

We also go back in history, look at how

this company or this house has traditionally

been valued, versus other ones in the neighborhood

or versus other communities.

And how is it being valued now?

So measures of absolute and relative value--

absolutely cheap on a rental basis,

relatively cheap on all different kinds of measures

that make sense to you--

now, you wouldn't use any of these measures

all by themselves.

If you just used relative cheapness-- if some of you

remember the internet bubble, and you

bought the cheapest internet stock, that wasn't cheap.

It was just cheap relative to all

the other crazy-priced stocks at the time.

But we use our measures of absolute and relative value

as checks and balances against each other

to try to zero in on fair value.

So when you do this--

I just want to show you a simple chart.

This is actually a study we did of our valuation methodology,

very similar to the way I just said we value a house.

This is how we-- we looked at the 2,000 largest

companies in the US over a 20-year period.

This was 1992 to 2012, and we ranked them on a daily basis

from 1 to 2,000, based on their discount

to our assessment of value, using these metrics.

The x-axis here-- you probably can't see it--

is just a valuation percentile.

All this means is if you were in the bottom left-hand corner,

and you were in the first percentile,

you're the 20 companies at any particular time,

out of those 2,000, that measure cheapest,

according to our measures of absolute and relative value.

Go to the 99th percentile--

you would be the 20 companies that measure most expensive

out of those 2,000.

The y-axis is the year forward return on average

during those 20 years.

What this chart simply says is, on average,

stocks that fell in our first percentile, the cheapest 20,

averaged a one-year forward return during those

20 years of 38%.

Stocks that ranked in our second percentile

averaged a one-year forward return of about 37%.

And then we drop down to this best-fit line, which we always

say we don't mind missing when we're making extra money.

And then as we measure something more expensive,

the year forward return drops.

And if you were sitting in my class at Columbia and I said,

hey, does anyone see a long-short strategy

you might pursue if you could predict ahead

of time which stocks would do best, second best, third

best, in order, and you did not say,

I guess I'd buy these guys up here

in the upper left-hand corner and short

these guys in the bottom right-hand corner--

if you didn't say that, I'd probably throw you out

of class, because it's very straightforward.

That's what you should do.

And by the way, that's what we do.

The important thing to understand