You Can Be A Stock Market Genius
by Joel Greenblatt
June 25, 2008
I have to admit, this book has been sitting idle on my bookshelves for quite some times now, the reading from Joel Greenblatt’s other book, “The little book that beats the market” did not leave me much of impression. It was the basics of value investing, no (significant) value added. This book, however, now that I wished I had read it much sooner, is one of kind, which covers special situations, such as Spin-offs, Risk Arbitrage and mergers, Bankruptcy, Recaps, LEAPS, warrant and options. The opportunities where money can be made with limited risks if one is willing to do the homework. Both Warren Buffett and Benjamin Graham had mentioned about special situations in their books, but none had discussed it in details and in cases studies where Joel Greenblatt has illustrated in this book.
The ability to take advantage of special situation is like adding a new tool in your toolbox. After reading this book, you would no longer just glimpse over the Wall Street Journal headliners, leaving stones unturned; instead, you would know where to look for a chance to fattening your wallet. In addition to these special situation discussions, Greenblatt covers some basics points in the first chapter of the book. Now, onto those sparkling stones…
Regarding to general investing in these special corporate situation: “Your investment advantage is usually at its greatest immediately before, during, and right after the corporate event or change.”
“Stocks of spin-off companies, and even shares of parent companies that do the spinning off, significantly and consistently outperform the market average.”
“In the Penn State study, the largest stock gains for spin-off companies took place not in the first year after the spin-off but in the second.”
Insider participation is the MOST important area to look, if you can determine what’s in it for the insider.
“if parent company appears to be an attractive investment, it is usually worthwhile to buy stock in the parent before the spin-off takes place.” Intuitional investors have tendency to wait after the spin-off complete to invest, which can drive the price up. By invest after the spin-off, it relieves the big players from selling unwanted spin-off stocks and the risks of incomplete transition.
In partial spin-off, by revealing the market price of the spin-off company, investors will have a better chance to price the rest of the spin-off holdings in the parent company.
Often stock options are tied to management’s stock options, so it’s management’s own interest to improve the price of spin-off after the set by the market, not before.
Side note: being in the first special situation covered and about fourth of pages in the books are used to cover in Spin-off. You get the sense that Spin-off is perhaps favored by the author.
Risk Arbitrage & Mergers
Risk Arbitrage takes place after the merger announced is already made. It is the arbitrage on the price offered over the market valuation, which tend to be a small percentage off the offered price at risk of the merger not going through.
Greenblatt recommend NO to this small chunk of gains in risk arbitrage.
Greenblatt recommend YES to Merger securities.
“Both spin-offs and merger securities are generally unwanted by those investors who receive them. Both spin-offs and merger securities are usually sold without regard to the investment merits.”
Bankruptcy & Restructuring
Bankruptcy can be a worthy investment opportunity, but require careful study. In general, buy bonds or bank debts instead of common stocks. Invest companies with attractive business.
Like Spin-off, Restructuring can uncover some great values, “look for situation that have limited downside, an attractive business to restore around, and a well-incentivized management team.”
Recaps, Stub stocks, LEAPS, Warrants & Options
Recaps, by leveraging the balance sheet, is a tax-effective way to distribute earning to shareholders. Newly created bonds or preferred are paid to shareholders in this way. Stub stock is the leveraged equity stake that remains after the company has be recapitalized which can be lucrative. Unfortunately, recaps are considered out of fashion.
LEAP stand for long-term equity anticipation securities or refer to as longer than one year option contracts. In essence, it is same as stub stocks, but you can purchase whenever, with one major difference. Option as limited time frame, stub stocks are call options without expiration dates.
Warrants is right to buy stock at specified price for a set period of time. Difference versus options, is that warrant is contract between the holder and the company, whereas options is between investors. Furthermore, warrant have longer time to expiration than options.
Greenblatt said this three times in the end-of-chapter-summary regarding Stub stocks, LEAPS, Warrants and Special situation options: “There is almost no other area of the stock market where research and careful analysis can be rewarded as quickly and as generously.”