Book Title: YOU CAN BE A STOCK MARKET GENIUS (Even if you are not too

smart)
Author: JOEL GREENBLATT
Year of Publication: 1997

INTRODUCTION:
This book gives an overview of how even someone without the prior knowledge of the
stock market can succeed with the set-out techniques which I will consider off main
street tips or as described by Joel Greenblatt.

CHAPTER 1/2:
The book reports different situations that the author has deemed to be “special
situations” that may offer profitable opportunities to investors who are willing to take
advantage of this type of situation. He also refers to them as the 'Secret hiding places"
of investment ideas. These ideas can be referred to as “out of the ordinary”, which
means they are off the Mainstreet. He explains how you can find, analyze, and most
importantly profit off them, e.g. Risk Arbitrage, Merger Securities, Bankruptcies,
Restructuring, Recapitalization, LEAPS, and Spinoffs.
The author also clearly defines some rules of when an investor decides to take
advantage of the special situations. "Do your work, don't trust anyone, always access
the downside, and not the upside and then pick your spot.

There is some industry or company information readily available, it is better not to trust
anyone as no one will provide you with information about a good investment deal. The
author describes this scenario as winning a lotto without buying a ticket. However,
most available information hardly focuses on attributes that will make your investment
opportunity special or attractive hence the reason why an investor should do their
homework. Another reason to carry out personal research is to ensure that when
placing an investment bet the reward will most likely promise to outweigh the risks.

Although there are investment analysts who mostly specialize in specific industries
and the author also establishes that most analysts are cut off from important sources
of information such as spinoffs, mergers etc. Hence the reason why limiting your
investments to industries in which you have vast knowledge and confidence is very
important.

The author also gives an insight into the nature of value investment by illustrating his
in-laws while in full capitalist mode with a strategy of buying assets at a bargain and
selling at market price. In this case, the in-laws never predicted if the market price of
an item will go up in the future, they simply ensured to buy at a significantly discounted
current price which simply guaranteed a profit when they eventually sold the item.
When compared with investors who buy stocks that are selling at a discount at market
price and then sell when the value of that stock is realized by the market.

In the case of reducing risk, it is important to understand that over diversifying your
portfolio does not guarantee lesser risks, so rather than buying more stocks, it is better
to put your money in the bank, money market funds etc. This simply explains the
saying of not “putting all your eggs in one basket”.
It is okay to diversify your portfolio but how much of it is needed? The book further
explained a concentrated portfolio is better. Your decision or reason to sell your stock
should be mainly for investment merits not to solve immediate problems such as rent
payments, or medical bills. Hence leaving some of your money outside the stock
market is a better bet for diversification.

The author explains that non-market risk is the portion of a stock that is not related to
the stock market's overall movement, also statistics say that owning just two stocks
eliminates 46% of the non-market risk of owning just one stock. He also goes ahead
to explain the percentages of owning a Stocks portfolio, 4 stocks 72%, 8 stocks 81%,
16 stocks 93%, and 32 stocks 99%. He concluded that the effort of reducing risk by
buying four stocks is relatively small.

Looking for investments in places others are not looking seems to be a good strategy
but it is not enough, it is equally important to look in the right places. The question is
what would one consider the right place to find a good investment?.

CHAPTER 3: SPINOFFS
This is simply a situation where a company takes part of its business (for example a
department from the parent company) and makes it a new and independent company.
This can be to improve the value of that business, to separate bad business from good
business, to dump debt i.e., separating a department with debt from the parent
company, to benefit from taxes, to solve a strategic, altruist or regulatory problem.
Investing in spinoffs can be very profitable as the stocks from the spinoffs and the
parent company are consistent in outperforming the market average and up to 20%
return annually.
Where the opportunity lies in a spinoff would be the fact that the shares from a spinoff
are sold back to the old shareholders of the parent company and these shares are
sold immediately at what I would call giveaway price or as described in the book
“without regard to price or fundamental value. Since a lot of spinoffs can be happening
at the same time it is important to be able to spot a more profitable spinoff from
another; these are ways to do so:

1) Institutions don’t want it based on reasons that they don’t involve the investment
merits, i.e., a fund is restricted from holding positions in the spun-off entity due to its
size, the index it's listed on, the industry it's engaged in.
2) Insiders want it, i.e., if the management of the parent or 'insider shareholders' load
up on the stock or is greatly incentivized to make the new entity a success through
i.e., a stock option programme.
3) A previously hidden investment opportunity is uncovered, i.e., the stock is cheap
due to an initial selloff, the spun-off entity is a great business, or a massively debt-
burden entity could make it a leveraged risk/reward situation (leverage can multiply
your returns, but not your loss).
According to the author, there are always opportunities to benefit from a spinoff but a
lot of attention needs to be paid to the wall street journal or other publications. Finding
an interesting spinoff is one part of the task while the second part would be to keep an
eye on the parent company announcements as it is still the same company and its
SEC form filling the document outlining the new spin-off company.
CHAPTER 4: RISK ARBITRAGE AND MERGER SECURITIES
Merger arbitrage simply means trading stocks in companies that are in the process of
a merger or a takeover. So basically, an investor is buying shares in a company at a
lower rate due to the takeover, the end game is to sell the shares at a higher price
when the deal goes through.
The author gave a clear illustration of company A announcing to buy all of company
B’s stock at a particular price so let’s say 30 Naira per share, before the announcement
company B sold at 15 Naira but after the announcement, company B began to sell at
28 Naira. This is where a risk Arbitrageur comes in to take advantage and buy the
shares at 28 Naira with hopes to sell when the deal pulls through at 30 Naira.

First off, the deal will most likely not pull through due to various reasons such as
regulatory problems, financing problems, extraordinary changes in a company’s
business, discoveries during due diligence or in some cases a party involved in the
merger can change their mind and the deal might fall apart. In any case, this is a risky
business.
In the case of Merger Securities seems to be an array of hope as sometimes
companies use merger securities to pay for an acquisition. In cases where an acquirer
might use merger securities, they have exhausted all possible ways to get cash and
still want to issue more stocks.
Merger securities can be described as an add-on to have an advantage over a deal or
outbid a potential acquirer in an auction situation.
For example, a buyer can decide to offer cash and stocks for some other combinations
of preferred stock or debt to shareholders (Bond). Just like in cases of spinoffs where
shareholders receiving such merger securities mostly end up selling them lower than
what they are worth, merger securities are usually not wanted by shareholders
because they would usually fall outside the order of the funds that receive them
because of this the investors can acquire them after the merger has taken place hence
avoiding the risk of the merger not going through.

CHAPTER 5: BANKRUPTCY AND RESTRUCTURING

When a company files for bankruptcy it could be for various reasons such as
mismanagement, overexpansion, government regulation, product liability and a
change in company condition. However, the author explains that a well of opportunities
still exists in a company that has declared bankruptcy but it is important to pick your
spot within the area you intend to invest in so even if buying stocks from a bankrupt
company is not an option, although there are other opportunities such as bonds that
can trade up to 20% to 30% of their face value.
Unlike spinoffs shares bought from a bankrupt company are unlikely to result in a
portfolio with long term investments and this could be due to the reasons they went
bankrupt in the first place. Secondly, the quality of companies that come out of
bankruptcy may not be that great afterall. The author goes on to talk about a study
that was carried out in 1996 where companies that emerged or were emerging from
bankruptcy outperformed the market, he also explains a study around 1980 to 1993
where newly distributed bankruptcy stock outperformed the relevant market indices by
20% during their first 200 years of trading. Investing in bankrupt companies might not
be a total dead end after all but it is the author warns that this might not be the case
at all times except for stocks with the lowest market value.
Knowing when to sell is tricky and the author refers to it as the second part of the
equation, unlike buying where the basic formula would be to buy when no one is
looking or interested (this is where the investor has an edge). When stocks are bought
from a spinoff, merger securities or bankruptcy these circumstances become the
reason the stocks were purchased in the first place hoping that when the situation is
over the stocks would have a better market value (the edge is then lessened) so this
might be a reason to sell. However, it could be that the company is doing worse than
when the purchase was made, the author does not give a specific time when to sell
but a little tip would be to “trade the bad ones and reinvest the good ones”.
Restructuring usually will not happen under the best circumstances but gives room for
elaborate changes to be made that present an investment opportunity. This is because
the department or division being restructured sometimes might be hindering the
potential of the company's other businesses. He also gave an illustration of how a
department might be running at a loss due to this, affecting the general profit of the
company regardless of how well other departments might be doing.
There are two major ways to take advantage of corporate restructuring one way is to
invest immediately after an announcement is made. At this point, there are lots of
opportunities because it will usually take a little while for the rest of the market to
understand the effects of such significant change. Another way is to look out for
companies that would be considered due for restructuring, it is important to invest in a
company with minimal downside and also ensure that the restructuring is a significant
one before investing.

CHAPTER 6: RECAPITALISATION AND STUB-STOCKS:

Recapitalization can be described as mainly exchanging one form of financing for
another e.g., removing preferred shares from the company’s capital structure and
replacing them with bonds. So, if a company purchases a significant amount of its
stock and then exchanges it for cash bonds or stock, Cash and or securities can be
given to each shareholder through dividends.
The idea is that if a company should borrow money and pay it out to shareholders the
value of what is left is called stub stock or can also be referred to as an increase in
value, this happens because of the tax effects of interest payments on the debts to
reduce pre-tax income and also to reduces the tax burden.

The author also talks about LEAPS which means Long Term Equity Anticipation
Securities. They are also referred to as long term stock. The author went ahead to talk
about options but elaborated more on CALLS which he describes as borrowing money
to buy stock but with protection so the price of the stock includes your borrowing cost
and the cost of your protection. In this case, you leverage on the future performance
of that stock and this all for a while.
Owning a CALL is different from owning a stub stock. With a stub stock, you can only
lose your initial investment. However, LEAPS has more advantages over stub stocks
because they can be traded on many other companies while stub stocks, they can
only be traded in the companies that choose to recapitalise.
Warrants are like call options but are different in two ways firstly, in a situation where
when issued by an underlying company stocks can be bought all through the period
the Warrants are similar to call options but they differ in two ways, firstly as illustrated
in the book if an investor holds warrants to buy shares from a company at a particular
price during a period say 10 years the investor will buy the shares at that price all
through that period. Another way is that warrants have a longer expiration date from
when they are issued like LEAPS they can extend for a number of years even more
than LEAPS.
CHAPTER 7/8: RECOMMENDATIONS
Being a stock market genius will take some real practice and patience, understanding
the ropes is very important in as much as the book gives very precise directions to
areas where the odds might favour a new investor.
The book also explains that starting with a little number of assets would be a good way
to go and also applying good judgment is key. Investing more as you get more
confident would be the way to go. When making up a portfolio as a stock market
investor it is not advisable to just concentrate on one industry except you are an expert
in that industry.
It is possible to have an entire portfolio for spin-offs due to the opportunities they have,
this applies to LEAPS as well since they can be traded on hundreds of companies a
good percentage of a portfolio can be invested in them.
The author also goes on to explain that taking on a reasonable margin depth is better
to avoid selling your positions at the wrong time. Although the book acts as a guide it
can’t help you take most Decisions it is also important to do lots of reading of
company’s documents such as;
• The company’s quarterly filings (SEC FROM 10Q),
• The Companies annual reports (SEC form 10K)
• Information about the executive stock ownership, stock options etc. which can
be found in the annual proxy statement (Schedule 14a) etc.
Other recommendations are provided as well as other investment books.
Furthermore, when analysing a company it is important to have information about the
company’s free cash flow, this will give you an idea of how much actual cash flows
come into the company yearly rather than just going with what is reported as earnings.

CONCLUSION: In conclusion, the book gives an insight into the rare opportunities
available in the stock market and the best strategies to take advantage of them and
make maximum profits. For potential investors with little or no knowledge of this
investment style, one key strategy as recommended is to do your groundwork, which
means looking for any and every available information before investing in any industry.
“Patience as they say is a virtue” hence I would recommend being patient with yourself
as the whole process takes some to get used to.
Over diversifying your portfolio won’t necessarily reduce the risk of losing money so
rather than having a large portfolio it is better to invest in industries that you have good
knowledge of.
Spinoffs seem to be where the best investment opportunities are so building a portfolio
of spinoffs is not a bad idea after all.
Risk Arbitrage will always be a no while Merger securities can be taken advantage off.
Bankruptcy might have some opportunities but be very choosy. For cooperate
restructuring it is important to look for opportunities with very limited downside.
Stub stocks, LEAPS, and Warrants all have opportunities with proper research and
analysis.