In this post we will see top 5 takeaway and summary of the book You Can Be a Stock Market Genius, written by Joel Greenblatt. I am Master, Editor at NewMarketMaster.com bringing you the best tips and tools to reach financial freedom through stock market investing.
Have you heard stories about plumbers? He arrives at a customer’s house, taps on the pipe, and then tells the customer “that will be $ 100.” The customer replied “100 dollars! All you did was tap on the pipe …” The plumber replied: “Oh no, the tap on the pipe is $ 5, but knowing where to tap is another $ 95”.
This is where the following points take root. . . Where to tap. As with all investment strategies, you need to have an advantage in the market. According to Joel Greenblatt, the founder of Gotham Asset Management, in special company situations, there is a great opportunity to start tapping profits.
From 1985 to 1994, Joel Greenblatt achieved an annualized rate of return of 50% per year, which is a huge rate of return. The investment record can be greatly improved, by investing in companies during special situations.
Top 5 ways you can be a stock market genius
Takeaway number one: Spinoffs.
The first and perhaps the most lucrative investment area for special corporate events is spin-offs. A spin-off is when a company takes a subdivision and separates it from the parent company, making it a separate entity.
A study that spanned 25 years and ended in 1988 found that splits had outperformed the S&P 500 by 10% per year for the first three years as independent companies. In addition, the parent company managed to exceed the market average by approximately 6% per year. Other studies have found similar results. So on average, with a basket of spin-offs, one would have achieved returns of around 20% per year without any talent or extensive research.
Imagine choosing your positions within this area and further increasing those returns. Even though that period ended 30 years ago, the same mechanics that allowed those returns to splitting back then are at stake today. The institutions do not want them.
A spinoff company may be too small for institutions to own and is often not the reason they bought the stock in the first place. This creates an initial selling pressure on the stock that has nothing to do with the business itself. The spun-off company lacks existing analyst coverage. This makes private investors doubtful and further increases initial stock dumping.
The spinoff operators have suddenly increased incentives. This independent entity is now no longer hidden in some subdivision of its parent. Combine this with greater freedom to operate and it makes an acceleration in the spin-off business more likely. There are additional mechanisms that make splitting a profitable area, but these are the main ones.
Greenblatt devotes most of the book to spin-offs, and claims that you don’t have to go beyond this and you can be a stock market genius.
Take away number two: Merger Securities.
Another special type of corporate event is the M & A event, where you should pay attention to the special types of merged securities that are sometimes used in these transactions.
Understanding Mergers and Acquisitions
Usually, when one company buys another company, most of it is paid in cash and stocks. However, in order to further increase the transaction price, or when the acquirer does not want to issue more shares or raise more cash, it may decide to use other consolidated securities. The opportunity arises because, generally speaking, no one really wants these other securities.
A company called Mash is producing and selling canned mashed potatoes. The stock transaction price is $ 31 per share. When another company, Franky’s Fries, announced that it would bid for Mash at the price of 7% of Frankie Fries’ 7% bonds due in 2032 at $ 39 per share in cash and at a face value of $ 4.
For shareholders, this is quite good, and their investment portfolios have paid off handsomely overnight. But how do people usually deal with earnings? Well, the cash part is easy, they can reinvest. What about bonds? By 2032, an annual coupon return of 7% and a face value of $ 4 will be obtained. In terms of risk-reward, this is actually a good deal, but who cares? A Bond with Mash?
People own stocks because they want to own their favorite mashed potatoes brand, not some kind of boring bond. Therefore, they will not think twice about selling the combined securities. What is face value? But what about institutional investors? Of course, they will do some advanced calculations in Excel. Set the rate of return as the benchmark for maturity, analyze the synergy between the two companies, and so on.
Institutions that own Marsh’s stock also want to acquire the company’s stock, not the new group’s bonds. This is where you enter the picture. Similar to the dynamic changes in the spin-off situation, the merger situation can make you a lot of money, and it must be handled correctly. Since both individuals and institutions quickly withdraw from the market, the selling pressure makes the stock transaction far below its actual value, so you can trade here.
This is important concept to understand so that you can be a stock market genius.
Takeaway number three: Risk Arbitrage.
As many great individuals and investors have advocated, start with something you don’t do in stock markets. This special situation needs to be avoided, that is, risk arbitrage or sometimes called merger arbitrage.
Understanding Risk Arbitrage
Let’s go back to Mash and Frankie’s Fries example. Suppose Mash’s shareholders declined the bid to buy the $ 39 plus bond. Now Frankie decides to raise the bed a little and pay in cash. We currently offer $ 60 for cash only. Stocks previously traded at $ 31 per share, but in anticipation of the completion of this bid, the stock market pushed the stock up to $ 58.
In Risk Arbitrage someone who buys Mr. Mash for $ 58 and expects the transaction to be completed as soon as possible to cash out the difference of $ 2 per share. There are many great ways to make money on the stock market, but according to Joel Greenblatt, this is generally a bad thing.
There are two main risks in trying to do this; there are always possible acquisition failures due to a variety of reasons, including financial issues, special events after the announcement, and findings during the due diligence process.
In this case, the downside is huge, and it is not uncommon for the stock to fall back to the transaction price before the acquisition is announced. Therefore, in the above example, the upside is $ 2, and the potential downside may be $ 25 to $ 30.
The second risk is time. The time required for the acquisition may be much longer than originally expected. If you have to wait, for example, it takes 12 months to complete the transaction, then your annualized return is about 3.4%. Considering that the stock market is full of other opportunities, this is a terrible use of your funds. Similarly, there are many ways to make money in the stock market, please do not choose risk arbitrage.
Takeaway number four: Restructurings.
Going back to the kind of special corporate situations you should try to understand and participate in, is restructuring. When we talk about restructuring, I am not referring to small adjustments, I am referring to situations when companies decide to sell or close an entire division. This happens on a regular basis, and if you’re watching you can spot some real opportunities here. You can make a lot of money here and you can be a stock market genius.
Generally, the reason for selling or closing an entire division is simply that your business is not doing so well. Suppose that a company has three divisions and generates a profit per share of $ 4 in total, but if you look under the hood, (which I hope it will do in these events from now on), you will discover that division A contributes profits of $ 2 a share, division B at $ 5 a share and the third, division C actually carries the bottom line with $ 3 a share. Generally, the company earns $ 4 a share.
But once division C is gone, earnings per share will jump to $ 7 and this will likely lead to a rise in the stock price. Additionally, another factor contributing to making this area potentially lucrative is that management can now focus more time and effort on developing the part of the business that is most profitable, which will likely lead to better results in the future.
It is often a difficult decision for management to decide to close a large part of their operations, as it means that from now on, they will lead a smaller organization. This is bad for people with big egos. Management teams that decide to shut down an entire division, therefore, show that they put shareholder interests first, and these are the leaders they want to invest in.
Takeaway number five: How to act in all special situations.
This last conclusion is a mix of things to keep in mind when it comes to these special situations. Some may be the repetition of other videos on this channel, but hey, repetition is the mother of all learning. Don’t trust anyone under the age of 30, and don’t trust anyone over the age of 30.
Don’t trust anyone at 30 either, do your own homework diligently so you can be a stock market genius. If you must consider special corporate situations because very few people do, you simply have no choice but to dig your own. You can beat the rest of the market with these methods because you will stand out from the pack and understand something that other people don’t understand. Invest with operators: as with all investments, you want to be on the same side as insiders; make sure the administration has skin in the game.
How you can be a stock market genius?
Taking the spin-offs as an example, the new independent entity will open up the possibility for the new CEO to buy shares in the company, but if he or she doesn’t bother, you shouldn’t either. Choose your locations and focus: While you can achieve extraordinary results by investing in special events, it is a minefield. Therefore, be sure to choose your places carefully.
But once you’ve found one of these gems, make it count by investing big. However, after you have distributed your money in about 6 to 8 of these situations, the benefit of adding additional investments to lessen the risk is small.
Once you have an egg basket, just make sure you look at it carefully. If you are not willing to make the effort to learn and identify these kinds of special situations, you are completely fine. So you might want to see a more passive approach to investing, like the one in Joel Greenblatt’s other book: The Little Book That Beats The Market. This book reveals how to spend a minimum amount of time and still be able to reap a lot of the rewards that the stock market offers. I encourage friends!