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You Can Be A Stock Market Genius.
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Showing posts with label
You Can Be A Stock Market Genius.
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Value investor Joel Greenblatt takes the reader through a number of categories of investing examples where market inefficiencies exist. This book has numerous case studies, giving the investor a chance to learn and then apply the lessons to current and future market opportunities
In this final chapter of the book, Greenblatt brings up some final points that are essential to being a successful investor. First, investors must enjoy not just positive results, but also the journey and challenge associated with finding undervalued securities. If you don't enjoy investing, a passive investment approach is probably more suitable.
Temperament is also important. If you're the type to sell your investments in a market panic, this type of investing is not for you. You must be patient and more confident in your own skills as an investor than in those of Mr. Market.
Greenblatt also notes a special characteristic about the investment situations he has described in the book. Many of them will not trade with the market, because they are special situations. As such, Greenblatt argues that even if the market falls or stays flat over a long period of time (e.g. as they did from the late 1960's to the early 1980's), investors using these strategies should still do well.
Value investor Joel Greenblatt takes the reader through a number of categories of investing examples where market inefficiencies exist. This book has numerous case studies, giving the investor a chance to learn and then apply the lessons to current and future market opportunities
Now that Greenblatt has provided readers with the types of opportunities in which they should invest, he now discusses how investors can find these opportunities. The first and most important step is to read the business news. Greenblatt recommends the Wall Street Journal in particular, but notes that all business sections of any newspaper are useful. While millions of other investors are doing the same, they are not interested in the same things as readers of this book.
Greenblatt also recommends that readers subscribe to a few newsletters. There are newsletters that cater to turn-arounds and special situations. Furthermore, investors can check out the holdings of various value managers by reading their prospectuses and checking out their filings. These starting points will provide a plethora of ideas; but investors must investigate and only focus on the best ones that they can understand.
On that note, Greenblatt goes on to discuss how investors can fully investigate ideas once they have identified them. He discusses some of the important SEC filings that investors must go through. He also discusses the difference between net income and cash flow and when investors should use one and not the other.
Value investor Joel Greenblatt takes the reader through a number of categories of investing examples where market inefficiencies exist. This book has numerous case studies, giving the investor a chance to learn and then apply the lessons to current and future market opportunities
Greenblatt introduces yet another class of investments where he believes opportunity exists for value investors: recapitalizations. Companies with strong balance sheets will often borrow large amounts of money for the purpose of buying back shares. Sometimes, the debt is issued to the equity holders, who will often sell the securities (as they don't match the investor's mandate) to an attractive level.
But Greenblatt argues that the real benefit is in the small equity portion that remains. For one thing, the company's financiers now get to keep a bigger part of the company's earnings, as interest payments are tax deductible. For many companies, debt also has a lower cost of capital, so the company's value also increases. For companies with increasing earnings, the added leverage also magnifies the gains to equity holders. Investors must be careful, however, as the added leverage also increases risk.
Such transactions are difficult to find, however. Therefore, Greenblatt recommends a synthetic method to "manufacture" a recapitalization: using LEAPS. Greenblatt suggests long-term call options can often be a way to generate returns far superior to the risk taken, and this mimics what is possible during a company recapitalization.
Often, investors can take advantage of market inefficiencies in how options are priced. The mainstream finance industry uses an option's underlying stock price's volatility to price the option. But sometimes, events in the future (e.g. a spin-off) can result in higher volatility than past price movements would imply. It is here than investors can profit, by buying calls where past volatility is not a good guide for future volatility.
Some of the drawbacks of LEAPS in comparison to recapitalizations are the fact that the company does not gain tax benefits (unlike a debt issue), there are expiration dates to the options, and management is often not incentivized with shares as they often are in recapitalizations.
Value investor Joel Greenblatt takes the reader through a number of categories of investing examples where market inefficiencies exist. This book has numerous case studies, giving the investor a chance to learn and then apply the lessons to current and future market opportunities
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.
Value investor Joel Greenblatt takes the reader through a number of categories of investing examples where market inefficiencies exist. This book has numerous case studies, giving the investor a chance to learn and then apply the lessons to current and future market opportunities
While spin-offs can lead to success (as discussed in the previous chapter), risk arbitrage is a loser's game, argues Greenblatt. Whereas investors used to be able to make money by buying stocks of companies with announced takeovers, that is no longer the case. Competition has reduced the spreads between current prices and the take-out prices, resulting in a lot more risk (as a result of financing falling through, buyers who change their minds, macro events etc.) than the rewards warrant. Greenblatt has had a few "sure-thing" lookalikes fall apart, and strongly advises against risk arbitrage.
However, that doesn't mean Greenblatt thinks one can't make money from mergers; it just has to be done in a different way. Greenblatt advises readers to scrutinize special merger securities. These are securities that are often thrown into merger deals as "sweeteners" to top a bid or convince shareholders to sell, without actually requiring further financing. For example, a buyer may offer cash plus stock plus some combination of warrants, preferred stock or convertible debt to shareholders of the target. It is the warrants and other non-cash, non-stock securities that Greenblatt says often get overlooked.
The idea behind this market inefficiency closely resembles that of the spin-off: shareholders receiving such merger securities often sell them, pushing their prices down in relation to their values. Like a spun-off company, merger securities are often not desired by receiving shareholders; for example, they often fall outside the mandates of the funds that receive them. As such, investors can purchase these (after having done the research on them, of course) after the merger has taken place, thereby avoiding the major risk: that the merger won't close.
Greenblatt takes the reader through a few examples where he has been able to purchase discarded warrants and preferred shares for a discount, as they were sold by shareholders who received them as part of a merger transaction.
Value investor Joel Greenblatt takes the reader through a number of categories of investing examples where market inefficiencies exist. This book has numerous case studies, giving the investor a chance to learn and then apply the lessons to current and future market opportunities
In this chapter, Greenblatt explores the world of spin-offs. The first point he makes is that spin-offs themselves generate above-average returns for investors. There are many logical explanations for this phenomenon, including the fact that owners of the parent company don't often want the spin-off as it may not be in the right industry or may not be of a size consistent with the investment mandate. This causes a sell-off of the spun-off company, resulting in an abnormally reduced price. As a result, investors tilt the odds in their favour just by venturing into this area.
With a little more work, investors can enhance even the already high returns that accrue to spin-offs by picking their spots, Greenblatt argues. He takes the reader through several examples of spin-off opportunities where prices appreciated strongly in subsequent periods due to market inefficiencies.
There were several recurring themes in the examples. Greenblatt looks for spin-offs where insiders own a lot of the stock of the new companies. He argues that managers will set themselves up for big returns, and so potential shareholders should look to align themselves with managers when possible.
Greenblatt also advises readers to look at the parent company of a spin-off as well. During partial spin-offs, for example, parent companies can trade at very low values relative to their ownership in the spun-off company.
Value investor Joel Greenblatt takes the reader through a number of categories of investing examples where market inefficiencies exist. This book has numerous case studies, giving the investor a chance to learn and then apply the lessons to current and future market opportunities
Greenblatt discusses some requirements that investors must follow if they plan to outperform in the market. First, they need to do their own work. The opportunities offering the best rewards will not be covered by the media or Wall Street. Investors must also not take advice from others, including brokers and analysts. These advisers are paid based on how much they generate in business for their firms, and not by how well you do.
Greenblatt also argues against too much diversification. For one thing, he cites research suggesting that as the number of stocks in the portfolio increases, the benefits of diversification drop quickly. For example, he argues that the diversification benefit between owning eight stocks and owning five hundred stocks isn't that large; but the benefit of owning eight stocks is that you can really pick your spots in terms of choosing stocks with potential upside that is higher than the potential downside. A better method of diversifying, Greenblatt argues, involves keeping some money out of the stock market (e.g. in cash, bonds, home equity etc.).
Greenblatt also advises that investors avoid looking at an investment in terms of its upside potential. Instead, look at the downside, and employ a margin of safety with all purchases. If you look after the downside, the upside usually takes care of itself.
Finally, Greenblatt discusses the fact that there are many ways to make money in the stock market. Every investor cannot possibly participate in even a fraction of the opportunities that are out there. Furthermore, there are many different methods by which investors can be successful. For example, Ben Graham used a quantitative, statistical approach, whereas Warren Buffett identifies and exploits competitive advantages. Greenblatt goes through a number of situations in the following pages that demonstrate the ways in which enterprising investors can profit from the market.
Value investor Joel Greenblatt takes the reader through a number of categories of investing examples where market inefficiencies exist. This book has numerous case studies, giving the investor a chance to learn and then apply the lessons to current and future market opportunities
In the opening chapter, Greenblatt explains how the ordinary investor has a chance against all the portfolio managers who dominate the market.
For one thing, many of the well-educated MBA-types subscribe to the Efficient Market Hypothesis, which makes them measure risk in an absurd way according to value investors. Price volatility is considered the best measure for risk for these market participants, and since value investors evaluate risk upon better measures (e.g. risk of bankruptcy, revenue risk etc.), opportunities are out there.
Second, institutional managers have a much smaller domain in which to invest. A billion-dollar fund can only buy positions in billion-dollar companies, or else the positions will either be so small that they will not affect returns, or the position sizes would be large and market-moving. Ordinary investors, on the other hand, have thousands more stocks to choose from, increasing the chances of finding a diamond in the rough.
In order to benefit from these advantages, ordinary investors have to look in places that no one else does, since the opportunities available to them will not be publicized. Greenblatt compares this kind of investing to antique shopping for bargains. Antique shoppers that have some knowledge of the market for certain objects can often find bargains in out-of-the-way places where others of their ilk aren't competing with them. Greenblatt argues that small investors must employ a similar strategy, and this book is dedicated to illustrating how.
