Joel Greenblatt Investment mistake.

Many good investors have always encouraged the use of an investment checklist to prevent or reduce investment mistakes made. The checklist can be compiled by analysing good investors past mistakes.(There are bounds to be mistakes).

I recently read a case study on Joel GreenBlatt most disastrous mistake written by J Allen Capital Management, the mistake on Key3Media was thoroughly analysed by them and it deserves a spot in all investor checklist. http://jallencapitalmanagement.com/posts/Joel-Greenblatt-Key3Media-Case-Study.html. From that article, we can see what leads him to buy the company and what was the eventual outcome.

Lessons of the story are high operating leverage,  economically sensitive industries and a material amount of debt.

Take note of companies that have a few customers that have high margins and make up the bulks of your revenue. This can result in high customer concentration risk.(Even worse, if those customers themselves are not doing too well).

                                                                                                                                                                                                                                                        

Beware of companies that are in economically sensitive industries that have experience a recent boom ( Technology industry in 2000, housing industry in 2006-2008 and the most recent boom can be seen in the oil industry). The underlying financials been analysed are overstated because of the recent boom. Reversion to the mean will occur eventually. In fact , this is one of the mistake made by Berkshire when investing in Cort Furniture during the technology boom.

Lastly, be wary of companies that scoop up high debts during the boom industry to fuel growth.

Well each factor alone can be quite dangerous but a combination of the above can be a recipe for losing a lot of money. During the boom, you could grow your profit without increasing your operating expenses, however during the downturn, your revenue and profits could vanish but your expenses remains unchanged.  As Joel Greenblatt mentioned, ”The tremendous operating leverage benefited from in good times was a double edge sword in bad times.” The revenue vanished will impact the net profit directly.