Gotham Capital

Gotham Capital is the legendary investment firm founded in 1985 by Joel Greenblatt, one of the most celebrated figures in the world of value investing. Launched with a modest $7 million, much of it from junk bond king Michael Milken, Gotham Capital achieved an almost unbelievable track record in its early years, posting annualized returns of around 50% (before fees) from its inception through 1994. The firm became famous for its sharp focus on special situations—complex corporate events that often create pockets of deep value overlooked by the wider market. Greenblatt’s work at Gotham not only made him a Wall Street icon but also laid the intellectual groundwork for his wildly popular and influential “Magic Formula,” a systematic approach to buying good companies at bargain prices that he later shared with the world. For everyday investors, Gotham Capital isn't just a successful hedge fund; it's the real-world laboratory where some of the most accessible and powerful value investing strategies were forged and proven.

Joel Greenblatt, alongside co-founder Robert Goldstein, established Gotham Capital with a clear mission: to exploit market inefficiencies through disciplined, value-oriented research. The firm's early strategy was anything but ordinary. Instead of simply hunting for statistically cheap stocks, Greenblatt dove into the nooks and crannies of the market, focusing on obscure and complicated events that most analysts either ignored or misunderstood. This specialization in corporate events like spinoffs, reorganizations, and bankruptcies paid off spectacularly. By identifying and investing in these misunderstood situations, Gotham was able to purchase assets for far less than their intrinsic worth. The firm's incredible performance during its first decade cemented Greenblatt's reputation as a “stock market genius,” a title he would later use for his first book, “You Can Be a Stock Market Genius.” In a surprising move, after nearly a decade of phenomenal success, Greenblatt and Goldstein returned all outside capital in 1994, choosing to manage their own fortunes and focus on individual projects.

Gotham's success was built on a two-pronged philosophy that combined deep-dive research into special situations with a disciplined, quantitative approach to value.

This was Gotham's original bread and butter. Special situations are unique corporate events that disrupt a company's normal business operations and, in turn, its stock price. Greenblatt realized that these events create powerful investment opportunities because they are often driven by legal or structural mechanics rather than pure business fundamentals, causing Wall Street to misprice the securities involved. Key examples include:

• Spinoffs: When a parent company divests a subsidiary into a new, independent public company. The new stock is often sold indiscriminately by the parent's original shareholders, creating a temporary price dip and a potential bargain.
• Merger Arbitrage: An investment strategy that seeks to profit from the price difference between a company's stock price after a merger or acquisition is announced and the final price paid for its shares.
• Bankruptcies & Restructurings: While seemingly terrifying, corporate reorganizations can unlock tremendous value, as the claims of the old company are settled and a new, healthier entity emerges with a clean balance sheet.

After years of hands-on experience, Greenblatt sought to systematize the core principles of his success. The result was Magic Formula Investing, a simple yet brilliant quantitative screen designed to find high-quality businesses trading at low prices. He outlined this method in his bestseller, “The Little Book That Beats the Market.” The formula ranks stocks based on just two metrics:

1. Return on Capital (ROC): This measures how good a business is. It asks, “For every dollar invested in the business, how much profit does it generate?” A high ROC indicates an efficient, profitable company. The formula is typically calculated as EBIT / (Net Working Capital + Net Fixed Assets).
2. Earnings Yield: This measures how cheap a stock is. It compares a company's operating profit to its enterprise value (market capitalization + debt - cash). A high Earnings Yield means you are getting a lot of profit for the price you pay. The formula is EBIT / Enterprise Value.

By combining these two factors, the Magic Formula identifies excellent businesses (Return on Capital) that are currently on sale (Earnings Yield), which is the holy grail for any value investor.

After returning outside capital in the 1990s, Joel Greenblatt focused on teaching and writing. However, the allure of the markets eventually brought him back. In the late 2000s, Gotham Capital was reborn in a new form: the Gotham Funds. This new family of mutual funds and other investment vehicles was designed to make Greenblatt's strategies, including long/short equity models based on his value principles, accessible to a much broader audience of everyday investors. This evolution marked a shift from an exclusive, private partnership to a public-facing asset manager, democratizing access to elite value strategies.

The story and strategies of Gotham Capital offer timeless lessons for anyone looking to build wealth through investing.

• Look Where Others Aren't: The biggest bargains are often found in the dusty, overlooked corners of the market, like spinoffs or other complex corporate events. A little extra research can yield outsized rewards.
• System Over Emotion: A disciplined, systematic approach like the Magic Formula can help you avoid emotional decision-making and stay focused on what truly matters: buying good companies at fair prices.
• Patience is a Virtue: Value investing is not a get-rich-quick scheme. The market can take a long time to recognize the true worth of an undervalued company. As Gotham's history shows, a long-term perspective is essential.
• Quality Matters as Much as Price: The cheapest stock is rarely the best investment. Greenblatt’s dual focus on both a cheap price (high earnings yield) and a great business (high return on capital) is a crucial lesson in avoiding “value traps.”