Book Review: Joel Greenblatt – You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits
Okay, time for another book review. This time, I’ll be reviewing Joel Greenblatt’s book, You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits. This book is not your typical investing guide because it focuses on how to (handsomely) profit from companies undergoing special situations (mergers, bankruptcies, etc).
Joel Greenblatt is the founder and managing partner at Gotham Capital, a private hedge fund that achieved 40% annualized returns since its inception in 1985. He has an MBA from Wharton and is an adjunct professor at Columbia Business School. He was a former chairman of the board of Alliant Techsystems (a Fortune 500 company), and co-founded the Value Investors Club website. He also wrote two more books on value investing, namely: The Little Book That Beats the Market and The Big Secret for the Small Investor: A New Route to Long-Term Investment Success.
Just like Peter Lynch, Greenblatt firmly believes that individual investors have certain advantages that can help them outperform most professional money managers. That is, if they know where to look. Some of the advantages that he points out are:
(1) Individual investors can do focused investing, as opposed to having a portfolio of hundreds of stocks.
(2) Individual investors have longer timescales, their performance are not evaluated the next quarter, so they can…
(3) Afford to wait for special situations to pan out.
Greenblatt firmly believes that big returns warrant you to search where nobody else is searching. This is the investment philosophy that they employ at Gotham Capital to achieve their impressive returns, and the application of this philosophy is what he will teach you in the rest of this book.
Non-core divisions are the usual candidates for spin-offs. Theoretically, these divisions are often neglected as a result of being part of a bigger corporation. However, when they are spun off, their young and motivated management team can now have the freedom and focus to make vast improvements in the business. Greenblatt points out that the key to a good spin-off opportunity is management having a direct stake in the business. In other words, if management’s compensation is based on performance, they will tend to perform well, and so shall the company’s stock price.
2. Risk Arbitrage and Merger Securities.
Although risk arbitrage is a bit too complicated for small investors, it is still a good way to make huge profits. This play usually involves mergers wherein one company acquires another with either cash or stock as payment. (Mis)pricing opportunities can be found in merger deals because acquirers usually pay a premium to the current stock price of their target companies. Simple arbitrage plays are done by buying shares in the target company to be able to profit from the spread when the premium is eventually offered, if ever. The main risk here is whether the merger will push through or not.
3. Corporate Restructurings
These usually happen when things go wrong. Usually, it’s either the company wasn’t performing well, or has gone bankrupt. This is not the time to be buying the stocks of these companies, but rather, the relatively safe senior debt that companies issue at deep discounts. As always, you need to know what you’re doing (via extensive research) if you’re going to try this.
4. Stub Stocks, Warrants. Options, and Leaps.
These derivatives are probably my most favourite tools for getting a piece of the action on Special Situations of companies. Please keep in mind though, that these are highly leveraged products and can do harm as much as they can do good.
Stub stocks are shares that represent only a small portion of the overall company. Greenblatt considers these as good investments because usually, another corporation owns the majority of the shares. So in theory, investors’ best interests will always come first.
Leaps are basically long-term options that investors can use to “wait-out” Corporate Special Situations. For example, if a corporate restructuring occurs, and you’re betting on a turnaround in 2 years’ time, you can buy Leaps to be able to participate in that turnaround without having to time your entry point. If the turnaround happens within the expiration period of your LEAPS, you make many times your money. If not, you’ll lose the premiums that you paid for, because like any other option, they also expire worthless.
Greenblatt wrote this book in a fun and easy to understand manner. It’s got lots of solid examples from Gotham Capital’s own playbook, which, quite frankly, is nothing short of stellar. As for me, this book has been a real eye-opener because it opened me up to so many investing possibilities. I used to be a strictly technical trader, but now I profitably use LEAPS to participate in companies’ Special Situations. All in all, this book should definitely be a part of every serious investor’s library.