How to Find Special-Situation Investments: You Can Be a Stock Market Genius by Joel Greenblatt

TL;DR

Joel Greenblatt’s approach is to seek an investing edge in special corporate situations, especially spinoffs, merger securities, and restructurings, while avoiding risk arbitrage. A 25-year study found that spinoffs beat the S&P 500 by an average of 10% per year during their first three years as standalone companies. Read on to understand where mispricing may arise and what risks to avoid.

Transcript

Have you heard the story about the plumber? He arrives at a customer's house and bangs on the pipes, and tells the customer that "That will be $100". The customer response "$100! All you did was bang on the pipes..." the plumber replies that "oh no, the banging on the pipes is $5, but knowing where to bang is another 95". This is where the followin... Read More

Key Insights

• ✋ Special corporate situations, such as spinoffs and restructurings, offer opportunities for higher returns in the stock market.
• 🖤 The lack of institutional interest and initial selling pressure can create undervalued securities within spinoffs and mergers.
• ✳️ Risk arbitrage carries significant risks and may result in substantial losses.
• ↩️ Selecting the right special situations and concentrating investments can maximize returns.
• 😤 Management teams that prioritize shareholder interests by shutting down divisions are favorable for investment.
• 👨‍🔬 Individual research and due diligence are crucial when exploring special corporate events.
• 👾 Investing with insider operators and those with skin in the game increases the likelihood of success.

Questions & Answers

Q: What are the main lessons from You Can Be a Stock Market Genius by Joel Greenblatt?

The main lesson is to look for an investing edge in special corporate situations such as spinoffs, merger securities, and restructurings. Greenblatt emphasizes selecting the right situations, doing individual research, concentrating investments, and favoring operators whose incentives align with shareholders.

Q: What is a spinoff in the stock market?

A spinoff occurs when a company separates a subdivision from its parent and turns it into an independent entity. According to the transcript, Greenblatt considers spinoffs among the most lucrative special corporate events and devotes most of the book to them.

Q: How have spinoff stocks historically performed?

A 25-year study completed in 1988 found that spinoffs beat the S&P 500 by an average of 10% per year during their first three years as standalone companies. Their parent companies also beat the market average by about 6% per year, while a basket of spinoffs produced returns of about 20% annually without comprehensive research.

Q: Why can spinoff stocks become undervalued?

Institutions may sell a spinoff because it is too small for them to own or because it was not the business they originally intended to hold. Limited analyst coverage can also discourage private investors, adding selling pressure unrelated to the underlying business.

Q: Why might a spinoff perform better after separating from its parent?

The operators of a newly independent company can receive stronger incentives and greater freedom to run the business. Because the operation is no longer hidden inside a parent-company subdivision, the transcript says acceleration in the business becomes more likely.

Q: What are merger securities, and why can they present investment opportunities?

Merger securities are instruments such as bonds that may be added to the cash or stock offered in an acquisition. Shareholders and institutions may quickly sell securities they did not intend to own, pushing their market price below their actual value and creating a potential opportunity.

Q: What is risk arbitrage, and why does Joel Greenblatt’s approach warn against it?

Risk arbitrage, also called merger arbitrage, seeks to profit from the gap between a target company’s market price and the price offered in a proposed acquisition. The existing page guidance warns against it because a deal can fail, the waiting period can extend, and the downside can be substantial.

Q: How can corporate restructurings create opportunities for investors?

A restructuring can improve a company when management sells or shuts down underperforming divisions. Eliminating those operations may improve future results, increase earnings per share, and support a higher stock price, especially when management prioritizes shareholder interests.

Summary & Key Takeaways

• Spinoffs: Investing in spinoff companies, where a subdivision is separated from the parent company, has historically resulted in returns of about 20% annually without comprehensive research.

• Merger Securities: Take advantage of the selling pressure on securities that are part of merger transactions, as individuals and institutions quickly sell them off, creating opportunities to buy undervalued assets.

• Risk Arbitrage: Avoid risk arbitrage or merger arbitrage, as it involves significant downside risks and longer waiting periods for potential returns.

• Restructurings: Look for opportunities in companies that sell off or shut down underperforming divisions, as the elimination of these divisions can lead to increased stock prices and better future results.