You can be a stock market genius

Joel Grenblatt

 

  • Look down not up
    • One way to create an attractive risk/reward situation is to limit downside risk by investing in situations that have a large margin of safety
    • The upside, while still difficult to quantify, will take care of itself
    • If you don’t lose money, most of the remaining alternatives are good
  • Special situations
    • Spinoffs
    • Mergers
    • Restructurings
    • Rights offerings
    • Bankruptcies
    • Liquidations
    • Asset sales
    • Distributions
  • You’re probably not going to be the next Buffett or Lynch
    • Investing in great businesses at good prices makes sense. But figuring out which are great ones is the tough part
    • Monopoly newspapers and network broadcasters were once considered near perfect businesses…
    • The world is complicated and competitive and only getting more so
  • Most successful investors generally don’t take comfort in crowds
  • Restaurant example
    • Selecting the restaurant was the important culinary decision – the individual item on the menu was less important because everything there would be good
    • In investing, if you preselect investment areas that put you ahead of the game even before you start, the most important work is already done

Spinoffs

  • On pure statistics, investing in both the parent and spinoff significantly and consistently outperform the market averages
    • On average by about 10% p.a. in their first 3 years of independence
    • Therefore, a portfolio of recently spun-off companies should, over the long run, return 20% p.a.
  • Spinoffs usually occur so that the separate business can be better appreciated by the market
    • e. a conglomerate in the steel and insurance business can spin off one business to create an attractive investment vehicle for someone who wants to invest in either insurance or steel, but not both
  • Sometimes they occur because the company wants to separate a “bad” business so that the “good” business can show through to investors
  • The reason spinoffs outperform is a feature of the spinoff function
    • Spinoffs are usually “given” to investors in the parent company for free
    • They are then typically sold immediately without regard to the price or fundamental value
    • They are usually much smaller than the parent company and can even force institutional selling due to liquidity/size constraints
  • When a business is freed from a large corporate parent, pent-up entrepreneurial forces are unleashed
    • Incentives & option schemes are also now likely to reward management teams of each business – rewarding parent and spun off business
  • In the study of spin-off performance, it found that they performed best in their 2nd year
    • Maybe takes a year for the initial selling pressure to dissipate
    • Or that the entrepreneurial changes and initiatives can kick in and begin to be recognised by the market
  • What to look for in an attractive spinoff
    • Institutions don’t want it, and their reasons don’t involve investment merits
    • Insiders want it – most important factor
    • Is the management team incentivized along the same lines as shareholders – stock option plans etc
    • A previously hidden investment opportunity is created or revealed
    • Tremendous leverage is an attribute found in many spinoffs
      • Remember, most company’s spinoff a company they can’t sell. Therefore, why not load it with debt too to make the remaining business ever more attractive?
    • If the parent of the spinoff looks like the attractive investment, purchase it prior to the spinoff as institutional investors may only look to buy after the event – leading to a pop in the share price post

 

” Of course, I never invest in situations with complete certainty anyway. Situations that make sense and offer attractive returns given the risks involved – that’s all I can really ask for”