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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
Interesting question that we all have the moment we have cash to invest, are the market overvalued, fairly valued, undervalued.. Hmm to answer that lets take a peek at the past, let’s see how has the market done in the past.
“History doesn’t repeat itself, but it does rhyme.” – Mark Twain
Digging up past record of Nifty since Jan-99 we have 13 years of data from which lets assess what Nifty has done previously. During the Bull Run 2003-08, we saw P/E rising at a much faster clip than the EPS i.e more speculative growth than fundamental growth.
However since 2011 we have seen EPS rising steadily while P/E declining, few of the reasons have been the Euro crisis, our own domestic issues (deficit etc) we as bottoms up investors should not excessively worry about macro picture too much, what is important is to find a high quality business that is growing profitably at a reasonably fair price and sit tight!
During the speculative period, we also saw P/B rising to dizzying high levels and some so called analysts (market pundits) justifying them.LOL since then their P/B has come down to about 2.9 levels. This study of ours shows one thing, we are not on either extremes means neither highly overvalued nor a flat bargain levels. Let’s dig deeper and analyze, try and view from different angles. (The table shows in percentage terms occurrence of events)
Our current Nifty data as on 4 September 2012, P/E – 17.69, P/B – 2.87, Div Yield – 1.57% (source: Nse website)
Comparing past 13 years, we see presently Nifty is at a P/E range 17-21 and it has traded 38.8% of times over our past data. Not exactly trading cheap!
Presently P/B of 2.87 indicates Nifty has traded 29.2% times in this range, not extremely expensive by any stretch.
The current Dividend Yield on Nifty stocks is 1.57% which is what 73.5% times Nifty has traded in past 13 years. Again we get no conclusive case of over or undervaluation.
So what do we interpret from the following data, The Valuations of market are not highly enticing and there may be a risk of further downside before any upside. Conservative investors must demand a greater margin of safety from their investments during such time. ( Why more margin of safety.?)
As Seth Klarman said in his book, “Margin of Safety”, Future is unpredictable. The river may overflow its banks only once or twice in a century, but you still buy flood insurance. “Investors must be prepared for any eventuality.” He describes that an investor looking for a specific return over time, does not make that goal achievable. “Targeting investment returns leads investors to focus on potential upside rather on downside risk.” “Rather than targeting a desired rate of return, even an eminently reasonable one, investors should target risk.”
Find undervalued opportunities and look for protecting yourself from the downside than looking to blindly participate in the upside.! Happy Investing!
By: Rohan Pinto (MMS 2011-13)
“Though you may be last to discover your follies, be always first to correct them.”
In Life it is so easy to talk about your accomplishments, talk about things that have got you the results you had desired but what remains hidden are the mountains of mistakes made in reaching the final destination. They say “Don’t let the truth get in the way of a good story” Lol.. More often than not that’s what most of the success books are all about.
They filter out the difficult part in one line and the story of success is what people see. It had been a rude awakening to the freaking truth of life that, it is okay to make mistakes, what is essential is learning out of it. Hmm.. But why suddenly all this love and writing about making mistakes, A few days before I read Howard Marks Memo titled “It’s All a Big Mistake” and that made my grey cells wanting to write about it.
Mistakes!! When I first learnt about investing I believed there was a magic formula which if applied could tell you a value of buy or sell (I am sorry I know this sounds outright pathetic and you have taken me for a fool from now) but yeah those were times of 2007-08. Another of my freaking genius deductions was any company which sells for about half of its Book Value was a screaming bargain (Arghhhh.. now you want to disown knowing me or having read my blog) Hell, I even acted on my convictions and bought this company “Great Eastern Shipping Company Limited” India’s largest private shipping company.
With Net Profit margins hovering around 40%+, lot of cash in the balance sheet and trading at less than book value (Poof!) no analysis of capital expenditures nothing..I got into this value trap not realizing shipping is a cyclical business. To be honest I was rank one amateur who was going to get a kick on his backside.!
I purchased GESHIP at around Rs. 321 then again some at Rs. 307 knowing it had gone till Rs. 500 levels and it’s just a matter of time. (Embarrassment) What happened next was what always happens, bubble bursts, higher profits led to more competition, global turmoil, margins squeeze and stock tanks. I sold out at Rs. 248 in Feb 2011 thinking I should book my losses rather than the eternal hope for the stock to regain. The stock is currently at Rs. 246 as of today.
I started to understand my fallacy of falling into these valuation heuristics without doing my homework, I made a loss. I made a mistake. But my dear friends, that day I learnt my lessons the hard way, but learnt it thoroughly. There is no secret formula. Its only about hard work and lots of reading to get an insight into the company and only after analyzing all the variables and understanding how things work should you invest.!
It is true in your darkest times you will be willing to dig the deepest. Making Mistakes in relations can be painful and you feel horrible! A phase June-August 2011, when times were difficult personally is when I really started to learn things afresh and made myself busy and I read furiously all the time about companies, investment books (I had a heaps of them) and then started to make progress, understand businesses and then I was set on the right path but all this saga did require me making those mistakes.
Friends,we all learn from mistakes, now we either sit and make all mistakes ourselves at the cost of our money, agony and learn from them or learn from others mistakes through reading or in any other way.!
“Smart people learn from their mistakes. But the real sharp ones learn from the mistakes of others.”
We always have choices, and choices always lead to consequences.. Past few months have been like Enlightenment for me, My summer Project of Analyzing companies has thrown open this world which I read so much about, but in reality knew so little. I would write about my project report in detail pretty soon, it will be another long boring post. Lol.
“When you find your path, you must not be afraid. You need to have sufficient courage to make mistakes. Disappointment, defeat, and despair are the tools God uses to show us the way.”Rohan Pinto Batch of 2011-13 Reblogged from beatingthemarkets.wordpress.com
“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