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00:00GOOD TO SEE YOU HERE. > > PLEASURE. > > I WANT TO REMIND EVERYBODY YOU ARE A SECURITY INVESTOR WHICH MEANS YOU BUY INDIVIDUAL STOCKS AND IN SOME CASES, SELL STOCKS SHORT. THE QUESTION PEOPLE WOULD HAVE FOR AN INVESTOR RIGHT NOW IS AFTER A 10% OR ALMOST 10% SELLOFF, TO THE DEGREE LOOK AT THE MARKET AND DECIDE WHETHER IT IS CHEAP OR EXPENSIVE, IS IT CHEAP? JOEL: WE VALUE THE BUSINESSES IN THE S & P 500 BOTTOMS UP AND WE HAVE DATA GOING BACK TO 1990. WE CAN CONTEXTUALIZE WHERE DO WE STAND TODAY. WE APPLY THEM CONSISTENTLY OVER THE YEARS. WE ARE IN THE 22ND PERCENTILE TOWARDS EXPENSIVE, MEANING THE MARKET HAS BEEN CHEAPER 22% OF THE TIME. WE CAN GO BACK IN TIME AND LOOK FROM THIS, WHAT HAS HAPPENED AND THE MARKET IS UP 46% OVER THE NEXT YEAR, 10% TO 12%. WE ARE EXPENSIVE, OR ABOVE AVERAGE. 4% TO 6% IS CLOSER TO WHAT HAS HAPPENED IN THE PAST. ERIC: THE MARKET HAS REPLACED -- REPRICE FROM ITS PEAK PE BY 4.5 TIMES. DO YOU SEE THAT IS HEALTHY? JOEL: WE DO NOT LOOK AT PE. WE ARE LOOKING AT CASH FLOWS. THE MARKETS HAVE GOTTEN CHEAPER. IT WAS DOWN TOWARDS THE END OF SEPTEMBER, DOWN IN THE 14TH PERCENTILE. IT HAS DROPPED. IT IS NOT CHEAP. WHAT COULD HAPPEN FROM HERE? WITH EXPECTED RETURNS UP 4% TO 6%, ONE WAY TO GET BACK TO EXPECTED RETURNS OF 10% IS IF THE MARKET FELL TOMORROW, THE EXPECTED RETURNS WOULD GET CLOSER TO 10% A YEAR. THAT DOES NOT HAVE TO HAPPEN BECAUSE OF THE MARKET UNDER EARNED, MEANING HAD SOME NORMAL RETURNS IN EACH OF THE NEXT THREE YEARS, WE WOULD ALSO BE BACK TO A 10% EXPECTED RETURN. IT IS NOT HELPFUL FOR ME TO KNOW WHAT IS GOING TO HAPPEN IN THE NEXT THREE MONTHS. IT IS HELPFUL FROM AN INVESTMENT STANDPOINT OF, WHAT ARE THE PROSPECTS FOR THE MARKET IN GENERAL AND HOW EXPOSED , IF YOU ' RE TAKING PORTFOLIO EXPOSURE TO THE MARKET, WHERE SHOULD YOU BE? ERIC: TECH STOCKS AND IN PARTICULAR THE FAANGS HAVE LED THIS RECENT SELLOFF. HOW CHEAP WITH THOSE HAVE TO GET TO APPEAL TO YOU? JOEL: IT IS INTERESTING. THE THINGS WE ' RE SHORT ARE TRADING AT 50 OR 100 TIMES EARNINGS OR LOSING MONEY. THOSE ARE THE THINGS WE ' RE GOING TO BE SHORTING. WITHIN THAT WILL BE CERTAIN TYPES OF FAANGS STOCKS IF THEY ' RE NOT EARNING A LOT YET AND PEOPLE ARE PRICING IN ON 2020 EARNINGS. WE ARE NOT, WE OWN HUNDREDS OF STOCKS ON THE LONG AND SHORT SIDE. THE BUCKET OF COMPANIES THAT ARE TRADING AT 50 OR 100 TIMES, WE ARE LOSING MONEY. THAT IS THE WORLD ' S WORST INVESTMENT STRATEGY. THERE WILL BE SOME WINNERS AND YOU WILL KNOW THEIR NAMES BECAUSE THEY WON. IT IS THE WORST INVESTMENT STRATEGY AS A GROUP. SOME OF THEM WILL WIN AND YOU WILL KNOW THEIR NAMES BECAUSE THEY WON. WE ARE CONCENTRATING ON COMPANIES THAT HAVE 7% CASH FLOW YIELDS IN A 3% INVESTMENT ENVIRONMENT. WHILE THOSE MAY BE PRICED CHEAPLY BECAUSE PEOPLE ARE CONCERNED ABOUT THE FUTURE, EVEN THOUGH THEY ARE EARNING CASH NOW, WE STICK TO COMPANIES THAT ARE GUSHING FREAK CASH E CASH FLOW. THAT AVOIDS VALUE TRAPS. WE DO NOT THINK OF VALUE AS LOW PRICE BOOK, LOW PRICE SALES INVESTING. IF YOU ' RE TRYING TO FIGURE OUT WHAT A COMPANY IS WORTH AND BUY THAT A DISCOUNT, THAT WILL NEVER GO OUT OF FAVOR EVEN IF LU IS DEFINED BY MORNINGSTAR. -- EVEN IF BY YOU IS DEFINED BY MORNINGSTAR. IT MAY NOT OUTPERFORM THE MARKET GOING FORWARD. THAT DOES NOT MEAN MUCH TO ME. THOSE HAPPEN CORRELATIONS THAT HAVE WORKED WITH MORE THAN YOUR FAIR SHARE OF COMPANIES OUT OF FAVOR. WE ARE BY DOING BUSINESS BASED ON CASH FLOW AND THAT IS WHAT STOCKS ARE. ERIC: THERE ARE INDICATIONS IN RECENT WEEKS THAT MAYBE THERE IS A SHIFT, THAT MAYBE THE PREMIUM INVESTORS HAVE GIVEN TO GROWTH STOCKS IS COMING OFF AND THEY ARE BEGINNING TO APPRECIATE THE VALUE AGAIN. IT HAS BEEN A DECADE SINCE THEY APPRECIATED VALUE. WHAT ARE YOU SEEING? JOEL: WHILE I SAY WE ARE NOT TRADITIONAL VALUE INVESTORS AND WE ARE USUALLY CATEGORIZED BY A BLEND, THAT IS PART OF VALUATION. THEY PUT US IN BLEND, NOT TRADITIONAL VALUE. WHEN GROWTH IS GOING AND THESE ARE THE COMPANIES PRICED ON HOPE , WHEN THOSE ARE DOING WELL , THEY ' RE NOT GOING TO LOVE WHAT WE ARE DOING AS MUCH. WE WOULD LINE MORE WITH TRADITIONAL VALUE. THAT IS NOT OUR MARKET. THOSE DO NOT LAST. PRICES HAVE GOTTEN HIGH. THAT DOES NOT MEAN THAT THE NAMES YOU ARE FAMILIAR WITH WILL NOT DO WELL OR MEET THE EXPECTATIONS PEOPLE THING. AS A GROUP -- PEOPLE THINK. AS A GROUP, PEOPLE WILL JUST PAY UP FOR EXPECTED GROWTH. THAT HAS BEEN FROTHY. I WOULD EXPECT THAT TO COME BACK TO EARTH. ERIC: WHAT DO YOU EXPECT THE CATALYST TO BE? JOEL: I DO NOT KNOW. IF THE PENDULUM SWINGS TOO MUCH ONE WAY, JUST LIKE WE HAD A CORRECTION IN OCTOBER, THAT COULD HAPPEN. THINGS ARE MORE EXPENSIVE THAN USUAL. IT COULD PLAY OUT IN DIFFERENT WAYS. THE MARKET COULD FALL OR COULD UNDER EARN FOR A FEW YEARS. THAT IS THE WAY IT LEVELS OFF, LOWER RETURNS THAN WHAT PEOPLE -- ERIC: SOME THINGS MUST CONFUSE YOU IF YOU EVALUATE THE MARKET BASED ON THE THINGS YOU HAVE OBSERVED IN HISTORY, THE DEGREE TO WHICH COMPANIES WITH BAD BALANCE SHEETS HAVE NOT BEEN PUNISHED. JOEL: THERE IS A REFLEXIVE COMPONENT TO THAT. THE RUSSELL 2000, THE SMALL-CAP UNIVERSE, IS IN THE SIXTH PERCENTILE. FORWARD RETURNS HAVE BEEN FLAT. DEPENDING WHAT COMPANIES WE ARE TALKING ABOUT, THAT IS EXPENSIVE. THAT SHOULD COME BACK OVER TIME. IT IS NOT A GOOD IDEA TO BUY THINGS AT 100 TIMES PRETAX FLOWS. ERIC: YOU ' RE NOT A SYSTEMATIC INVESTOR. I WONDERED IF THERE WAS ANY WAY YOU WOULD EMBRACE SYSTEMATIC VALUE INVESTING. I KNOW YOU TEACH YOUR STUDENTS TO LOOK AT A SECURITY THE WAY THEY WOULD CONSIDER BUYING A HOUSE. WHAT IF YOU ARE BUYING A NEIGHBORHOOD? WOULDN ' T YOU EVALUATE ALL HOUSES ON AN AGGREGATE BASIS AND DECIDE IF ONE NEIGHBORHOOD WAS CHEAP RELATIVE TO ANOTHER AND MAYBE THE CHEAP NEIGHBORHOOD WAS WORTH BUYING? OVER TIME, THAT HAS WORKED. STATISTICS SUGGEST BY YOU IS A FACTOR. IT OUTPERFORMS GROWTH, EVERYTHING. JOEL: RIGHT, BUT THE WAY PEOPLE DESCRIBE VALUE , THE WAY THEY ARE CATEGORIZED BY RUSSELL OR MORNINGSTAR IS LOW PRICE BOOK, LOW PRICE SALES. THAT IS NOT A FACTOR WE LOOK AT. WE ARE LOOKING AT CASH FLOW. WE ARE BUYING THE CHEAPEST AND YOU BROUGHT UP THE HOUSE. IF YOU ARE BUYING A HOUSE, YOUR JOB IS TO FIGURE OUT WHETHER IT IS A GOOD DEAL OR NOT. IF I RENTED IT OUT AND I COULD GET $70,000 A YEAR AND THE INTEREST RATE IS 3%, DOES THAT SOUND GOOD? HOW CHEAP IS IT? WE LOOK AT A COMPANY AND SAY, HOW CHEAP IS A RELATIVE TO COMPANIES IN THE SAME INDUSTRY? HOW CHEAP IS IT RELATIVE TO THE MARKET? THESE ARE MEASURES OF RELATIVE VALUE THAT ANYONE WOULD USE. WE CAN ' T VALUE GOLD OR BITCOIN THAT WAY. EARNING ASSETS, THERE ARE STANDARD WAYS EVERYONE WOULD VALUE THEM. IF YOU ARE DISCIPLINED, THERE ARE OPPORTUNITIES. ERIC: ALWAYS GREAT TO SEE YOU.

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Why Gotham's Greenblatt Likes 'Gushing' Cash-Flow Stocks

Joel Greenblatt, co-chief investment officer and managing principal at Gotham Asset Management, discusses how the hedge fund evaluates targeted equities as part of its investment strategy. He speaks with Bloomberg's Erik Schatzker on "Bloomberg Markets: European Close." (Source: Bloomberg)

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