In this chapter, Greenblatt discusses another area where he feels value investors can make money: bankruptcies and restructurings. To be clear, however, Greenblatt strongly advises against buying shares of companies that are going bankrupt; these shares are usually soon-to-be worthless, but often trade for positive values. Furthermore, Greenblatt also recommends against buying companies going through the bankruptcy process; vulture investors are usually all over this area, spending tons of time to estimate the values of the securities that will emerge from the uncertain litigation processes.
Instead, Greenblatt argues that the opportunity for value investors is at the end of the bankruptcy process, where equity in the company is thrust upon the debt holders. Similar to the situation in spin-offs and merger securities (discussed in previous chapters), securities are being given to investors who don't want them. Banks and other bond holders aren't too interested in equity securities; as such, supply exceeds demand and these securities trade down following their issue. Investors must still pick their spots (by studying the value of the equity versus the price of the shares), but Greenblatt argues that this is a great place to find mis-priced securities.
Corporate restructurings are another area where Greenblatt says opportunities are abound. Often, a company will have a profitable division and a money-losing division (or some combination thereof). By selling or closing the losing division, the company is able to increase profits without really improving anything. Investors who buy at the depressed price stand to benefit when the company has shed the unit(s) that were dragging down profits.
Greenblatt also uses this opportunity to discuss the difficult decision of when to sell a security. He argues that investors should base this decision on the quality of the company. If the company is an also-ran in its industry, it should be sold when it trades at multiples similar to its peers. If, however, it is a strong company with solid returns, it should be held until it is clearly overvalued.
By Saj Karsan, Saturday, March 12, 2011, 6:20 AM | Joel Greenblatt, You Can Be A Stock Market Genius | 2 comments »