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You Can Be a Stock Market Genius – Joel Greenblatt
My only problem with this book has been its title. Not only is it tacky but it also gives a wrong sense to people. Apart from the title, it’s a very informative and useful guide to discover various methods to invest in Stock market. Before I dwell further upon this book, let me remind all those who follow Benjamin Graham – The father of Value Investing and an author of security analysis, he uses a term called “Special Situations”. The book is all about these situations.
The author of this book, Joel Greenblatt is the founder of Gotham Capital, a private investment partnership firm achieving 50% annual returns over a period of 10 years. Thus Greenblatt definitely practices what he preaches.
Joel Greenblatt has explained in a simplified manner, the nuances of Special Situations such as Spin offs, Restructurings, Merger Securities, Rights Offerings, Recapitalization, Bankruptcies, Risk Arbitrage. Each one of these provides ample opportunities to invest and generate profitable returns in them.
Some of these situations cannot be exploited by a Lay investor but some situations like Spin offs, Right offerings can definitely provide ample returns to the investor doing thorough analysis.
Spin-offs: Spin-offs are often but not always the result of a parent company wanting it to get rid of a subsidiary in order to focus on their core business. Since getting rid of the segment that is dragging performance helps in improving the valuation of Core Segments, the neglected spin off thus usually has a vast potential. All that is required for the investor is to find out more about the role of management post spinoff. If their compensation is based primarily on performance, they will tend to perform well. Of course, there are a million caveats but, if you do your homework properly, specializing in corporate spin-offs can dramatically improve your odds of earning high, sustainable returns in the stock market. The best part about these situations according to the author is that all the decisions to be taken about Company is on the basis of publicly available information. The author repeatedly warns to do homework!
Risk Arbitrage and Merger Securities: Joel offers a strict warning about the dangers of risk arbitrage by the small or retail investors, but risk arbitrage’s close cousin, the merger security, can offer outstanding profits to those careful investors.
Corporate Restructurings: A corporate restructuring means something went wrong! Either the company wasn’t performing up to the expectations or an outright bankruptcy might have occurred. Typically with these kinds of situations, one would stay clear of investing in a particular company. Upon thorough analysis one can think of investing if the risk is ascertained and the company is in process of a turnaround.
A simple example given by the author here is say a company has Equity of $5 and debt of $25. Its total worth is $30. Now a 10% increase in its assets will double the Equity component and thus the stock price. Caveat: A reversal of above circumstance may wipe your entire capital. Thus these circumstances must be thoroughly analyzed before investing money into it.
Stub Stocks, Warrants, Options, and LEAPs: Derivatives can make good investments, but leverage is something I personally don’t advocate. This is for people who know the nuances of trading in derivatives. Small investors like you and I can have a clear view on investments.
The Book I believe is worth reading because it provides one with a ground work on how to exploit these “Special situations” and gain profit from them. To sum up it is a well written book.
P.S: Joel Greenblatt if you are reading this, Please avoid giving tacky titles to your future endeavors.
MMS – A
Batch 2011 – 13
“Price is what you pay, value is what you get”
As an investor our aim is to buy low and sell high (ensuring profits) but most of us end up buying high (Believing that it can only go higher…Poof!) and selling at the bottom. Thus, the most important thing to remember is that valuation is an art and not a science! Hence, precisely valuing securities is bull crap.
John Keynes, an economist, said, “It is better to be roughly right than precisely wrong”. In our pursuit to buy underpriced securities our goal is to ascertain the approximate worth and not to be necessarily exact. This brings us to another problem. If I cannot value the exact price of the security how do I invest? (Don’t give me answers in Greek alphabets; I can’t understand them I am better equipped with my elementary math it gets the job done without confusions)
At what price to buy? That is when the concept of ‘Margin of Safety’ comes up. What is Margin of safety? It is the difference between your estimated price and current price of the security. When Investing we always want our margin of safety to be as high as possible. An analogy here is “if you have built a bridge which has maximum weight carrying capacity of 30K pounds only drive through 10-15 thousand pounds across it” that’s your margin of safety! It’s not necessary to precisely measure your load because you know that it is definitely way below 30K pounds!
Similarly buy securities which are so undervalued that you need not be precise with the intrinsic value of the security, there is a margin for error and because you have purchased the security well below the intrinsic value your risk considerably reduces.
This is what Ben Graham told to U.S Senate:
The Chairman: When you find a “Special situation” and you decide, just for illustration, that you can buy for 10 and it is worth 30, and you take a position, and then you cannot realize it until a lot of other people decide it is worth 30, how is that process brought about – by advertising or what happens?
Mr. Graham: That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know from experience that eventually the market catches up with value. It realizes it one way or another.
What Graham tells us is that all we have to do is try and buy securities at deep discount and have enough margin of safety so that eventually when the markets catch up with the security we get our returns.
“Even with a margin [of safety] in the investor’s favor, an individual security may work out badly. For the margin guarantees only that he has a better chance for profit than for loss – not that loss is impossible. But as the number of such commitments is increased the more certain does it become that the aggregate of the profits will exceed the aggregate of the losses.”
Thus this disclaimer by Graham clearly saying that this is not a sure fire way of profits but over the long run there will be positive returns.
“The market, like the Lord, helps those who help themselves. But, unlike the lord, the market does not forgive those who know not what they do.” – Warren Buffett
Ignorance is not bliss when you are investing! It’s dangerous when you are ignorantly investing with your money and can get disastrous if you are handling other people’s money!
How do you ensure that you are buying with a margin of safety??
These are a few pointers which an investor could use to determine if he has enough Margin of safety in his investment. (This by no means is an exhaustive list!)
Comparing your Shares / stock with respect to Bonds
Invest when the Earnings/Price (Invert P/E ratio, it gives the yield on investment) is greater than the Present AA bond yield. (Note: The value of Earnings in the ratio is preferably average of few years to ensure that data is not skewed)
Example: A company having a P/E (average) of 8 will give E/P value of 12.5% (adjusted for pre tax: 12.5/ (1-0.30) assuming 30% tax rate is 17.8%) and if the AA bond yield is 12% pre tax. You have a margin of safety of 30%+ on your investment when compared to a bond!
Comparing your estimated return from the security with your expected return (say if your minimum expected rate of return from investments is 15% i.e. your hurdle rate, and then you invest only when there is a security available at a price that offers more than 15% returns)
Finally, “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.” – Benjamin Graham
References: The Intelligent Investor – Benjamin Graham
The Fountainhead & Atlas Shrugged – By Ayn Rand
“Who is John Galt?”
A simple line that begins ‘Atlas Shrugged’. A cry of despair and helplessness that echoes throughout this book… does it find an answer and solace by the end?
‘Howard Roark’ – a name that sprang out of the pages of ‘The Fountainhead’ and became immortal.
The central character of ‘The Fountainhead’ is Howard Roark, an architect. He is a man unwilling to compromise on his principles. According to him a building must have integrity like a human being; it must be composed of a single theme and ideal. He does not want to build to have clients; rather he wants clients so that he can build.
He is met with severe opposition from the world around him. Does Roark triumph in the end and at what cost? The answer to this lies in this unique book.
“Atlas Shrugged” was written next in the 1950s. It is a combination of mystery, philosophy and science fiction. Ayn Rand once said “It’s a mystery story, not about the murder of a man’s body, but about the murder and rebirth of man’s spirit.”
It is set in an imagined future where all the countries in the world have turned to communism and there’s chaos everywhere. Even in the U.S.A, the government is taking over everything. Slowly, one by one, all the leaders in fields like science, philosophy, medicine, music and technology in the world start disappearing leaving the economy and the government in disarray.
Dagny Taggart, the heiress and operating vice president of Taggart Transcontinental, a giant railroad company, is convinced that there is a destroyer who is draining the world of its greatest brains and is determined to fight him/her to save it. As the world slips into further depression, people continuously express their helplessness through the line ‘Who is John Galt?’ But no one knows whether there was a John Galt, and how this line originated.
Does Dagny manage to find out the reason behind this massive exodus? Where have all the productive minds actually disappeared to? Does a John Galt really exist? What is the secret unlocking all these mysteries? The answers to all these are contained in this thrilling narrative.
Both the books are very thrilling and unique. There are flaws in them, of course. For example, in many places characters stop and delve on philosophical matters for a very long time. This disturbs the narrative economy and the flow. The lengths of the books may deter many readers.
But in my opinion these are minor blemishes. Also, as MBA students, I feel these books are very important for us. The excellent debates within them, the beautiful thoughts expressed about the nature of money, business, and indeed life itself, and the lessons of leadership that one can derive from them are invaluable.
Both ‘The Fountainhead’ and ‘Atlas Shrugged’ continue to live on even today, years after Ayn Rand passed away. During the recession in the late 2000s, sales of ‘Atlas Shrugged’ increased, with people feeling that they could further connect to it. Many CEOs have said that they benefited a lot reading it.
It’s my recommendation that you read these books. They will surely entertain you and set you thinking. You may not agree with everything they say, but you will not be able to deny their impact on you.
MMS – A
Batch 2011 – 13