How can you become a stock market genius? If you were to ask a hedge fund manager how to invest, what would they say?<\/p>\n\n\n\n
In You Can Be a Stock Market Genius<\/em>, Joel Greenblatt leverages his expertise as a hedge fund manager to inform laypeople about how they can begin investing in the stock market. He focuses on special-situation investing<\/a>, a type of investing that relies on finding undervalued stocks.<\/p>\n\n\n\n Learn more about how you can begin investing with these strategies from You Can Be a Stock Market Genius<\/em>.<\/p>\n\n\n\n\n\n\n\n Investing firms can overwhelm laypeople with their sheer range of options: actively managed mutual funds, passive index funds, exchange-traded funds, and more. But according to hedge fund manager Joel Greenblatt, the amateur investor doesn\u2019t need any of these options to earn above-market returns. On the contrary, in his 1997 book You Can Be a Stock Market Genius<\/em><\/a>, Joel Greenblatt argues that an approach called special-situation investing can yield lucrative returns that outperform the vast majority of investing funds.<\/strong><\/p>\n\n\n\n To outline this approach, Greenblatt examines an array of uncommon situations in the corporate world that spawn various promising securities (financial assets that you can buy and sell) at bargain prices. He discusses why corporate spinoffs often create incredibly cheap stocks, why bankruptcies can lead to underpriced equities, and why stub stocks<\/a> can provide exponential returns with limited downside risk.<\/p>\n\n\n\n As the founder and co-manager of Gotham Asset Management<\/a>, a hedge fund with a $4.6 billion portfolio<\/a> as of September 2023, Greenblatt distills years of concrete financial experience and expertise into his discussions throughout the book. Having authored several other public-facing books, such as bestsellers The Little Book That Beats the Market<\/em><\/a> and The Big Secret for the Small Investor<\/em><\/a>, Greenblatt is skilled at making dense financial concepts accessible to the uninitiated. <\/p>\n\n\n\n In this article, we\u2019ll discuss how special-situation investing uses insights from value investing, and we\u2019ll outline some of Greenblatt\u2019s general tips for investors. Then, we\u2019ll examine the specific situations that Greenblatt considers: <\/p>\n\n\n\n Throughout this article, we\u2019ll also discuss the risks associated with some of Greenblatt\u2019s special situations and update his arguments with research that\u2019s appeared since the book\u2019s 1997 publication.<\/p>\n\n\n\n Before exploring the specific situations that offer lucrative investment opportunities, Greenblatt discusses the fundamentals underlying these opportunities. In this section, we\u2019ll analyze these fundamentals, focusing first on how value investing lies at the core of Greenblatt\u2019s approach and then proceeding to Greenblatt\u2019s general tips for special-situation investors.<\/p>\n\n\n\n In You Can Be a Stock Market Genius<\/em><\/a>, Joel Greenblatt explains that successful special-situation investing rests on the foundation of value investing, which prescribes purchasing stocks at less than their fair value. He argues that by practicing special-situation investing, value investors can profit handsomely.<\/strong><\/p>\n\n\n\n Greenblatt explains that value investing essentially involves finding bargain investments. To illustrate, imagine that you\u2019re a baseball card collector who regularly sells baseball cards at auction and you find a card at a garage sale that costs $50. If you know that collectors have recently bought this card for around $100, then the card at the garage sale is underpriced\u2014it\u2019s selling for less than its true value. Thus, by purchasing the card at $50, you can make a profit of $50 by selling it for $100 at auction.<\/p>\n\n\n\n Further, Greenblatt argues that value investing creates a margin of safety that minimizes the risk to special-situation investors<\/strong>. The margin of safety, he clarifies, refers to the difference between a stock\u2019s true value and its share price. In the above Netflix example, your margin of safety would have been $32\u2014the true value of $330 minus the share price of $298. <\/p>\n\n\n\n Having shown how the tenets of value investing inform special-situation investing, in You Can Be a Stock Market Genius<\/em><\/a>, Joel Greenblatt then offers general tips for would-be special-situation investors. We\u2019ll focus on three key tips: invest independently, invest selectively, and don\u2019t blindly trust investment analysts.<\/strong><\/p>\n\n\n\n First, Greenblatt argues that you should perform your own research to find bargain investments<\/strong>. He writes that this advice stems from the nature of bargain investments\u2014because such investments are ignored and unappreciated by other investors, they\u2019re not heavily discussed by mainstream investing sources. For example, if The Wall Street Journal ran a front-page story on an allegedly underpriced stock, swarms of investors would likely invest in it, driving its price up and making it no longer a bargain. <\/p>\n\n\n\n Next, Greenblatt contends that you should invest sparingly, focusing on the stocks that you\u2019re most sure about<\/strong>. He asserts that by practicing this strategy, you\u2019ll maximize your chances of finding profitable investments while excluding those you know less about (and which are therefore riskier). After all, you never have to invest, so you can wait patiently to ensure your investments are always well-informed.<\/p>\n\n\n\n Finally, Greenblatt argues that you should avoid deferring to analysts because their interests compete with yours<\/strong>. For example, many analysts are paid by stockbrokers who earn commissions on stock sales<\/a>. Thus, analysts are incentivized to recommend buying companies even when these companies might be objectively unpromising. Moreover, analysts who criticize a company\u2019s stock often lose their access to inside sources, which makes them reluctant to issue \u201csell\u201d recommendations. For these reasons, Greenblatt believes you can\u2019t trust analysts to provide you with impartial recommendations.<\/p>\n\n\n\n Having discussed Greenblatt\u2019s general strategies for special-situation investing, we can now proceed to the first group of special investing situations\u2014those arising when established companies beget new companies and stocks. In this section, we\u2019ll focus on three such situations: spinoffs, partial spinoffs, and orphan equities<\/a>.<\/p>\n\n\n\n Spinoffs occur whenever a parent company decides to jettison one of its subsidiaries or divisions and create a fully independent company. According to Greenblatt, investing in spinoffs can yield above-market returns because shareholders of the new spinoff often seek to hastily sell their shares<\/strong>. <\/p>\n\n\n\n In You Can Be a Stock Market Genius<\/em><\/a>, Joel Greenblatt clarifies that when a spinoff occurs, the parent company typically distributes shares of the spinoff to existing shareholders. For example, if Warren Buffett\u2019s company\u2014Berkshire Hathaway\u2014decided to spin off Dairy Queen, one of its subsidiaries, then Berkshire Hathaway might distribute shares of Dairy Queen to its current shareholders to compensate them for the value lost when it jettisoned Dairy Queen.<\/p>\n\n\n\n In practice, this means that shareholders receive shares that they didn\u2019t ask for\u2014in the previous example, shareholders originally wanted to invest in Berkshire Hathaway, not Dairy Queen. Further, Greenblatt points out that these spinoffs are often too small for institutional investors, who only invest in large companies. The upshot is that investors sell the spinoff\u2019s newly created shares in droves, often making the spinoff\u2019s stock available at bargain prices. Greenblatt notes that, for this reason, spinoffs have historically outperformed the S&P 500 by 10% annually in their first three years, according to a 1988 study.<\/p>\n\n\n\n In a similar vein, Greenblatt discusses partial spinoffs, which occur when a parent company only spins off a portion of a division or subsidiary and keeps the rest. He argues that partial spinoffs can present promising investment opportunities\u2014both in the partial spinoff and in the parent company<\/strong>.<\/p>\n\n\n\n Investing in partial spinoffs, Greenblatt points out, can be lucrative for the same reason it can be lucrative to invest in spinoffs: Shareholders receive unsolicited shares of stock in the partial spinoff and thus have an incentive<\/a> to sell these shares at a low price. However, Greenblatt contends that the best investment opportunities<\/a> from partial spinoffs often involve investing in the parent company. He reasons that when a partial spinoff occurs, the market not only prices the spun-off division, but also allows us to calculate the value of the parent company minus the entire spinoff.<\/p>\n\n\n\n Finally, in You Can Be a Stock Market Genius<\/em><\/a>, Joel Greenblatt turns to so-called orphan equities\u2014the new stock of companies that emerge from Chapter 11 bankruptcy proceedings. He maintains that orphan equities can be lucrative investments because their initial owners are former creditors with incentive to sell<\/strong>.<\/p>\n\n\n\n Greenblatt first clarifies that when a company survives bankruptcy proceedings, new shares of its stock are issued and distributed to the company\u2019s former creditors\u2014those who hold the debt that the company can\u2019t repay. For example, if Netflix were billions of dollars in debt to banks and declared bankruptcy, then these banks would be compensated with newly issued Netflix stock if Netflix survived bankruptcy\u2014after all, if Netflix were bankrupt, it wouldn\u2019t be able to pay the banks back in cash.<\/p>\n\n\n\n Greenblatt recognizes, however, that stock in recently bankrupt companies is often deservedly low\u2014these companies went bankrupt, after all. So, to distinguish between fairly priced orphan equities that are unpromising investments and genuinely underpriced orphan equities, he endorses Warren Buffett\u2019s advice: Look for companies with sound underlying business models.<\/strong><\/p>\n\n\n\n In addition to the new investment opportunities arising from spinoffs and bankruptcies, Greenblatt also discusses how pre-existing companies undergoing significant changes can yield lucrative investments. In this section, we\u2019ll discuss two such changes: acquisitions and restructurings. <\/p>\n\n\n\n Acquisitions occur whenever one company purchases a majority of another company\u2019s stock from its shareholders, thus giving the acquiring company controlling interest in the acquired company. In You Can Be a Stock Market Genius<\/em><\/a>, Joel Greenblatt argues that acquisitions can create promising investment opportunities<\/strong> because so-called merger securities<\/a> are often sold at bargain prices. <\/p>\n\n\n\n While acquisitions enlarge an existing company, restructurings (the process of closing or selling an entire division) cut the size of an existing company. According to Greenblatt, corporate restructurings can yield lucrative investment opportunities for two primary reasons: They rid companies of unpromising divisions and they indicate that management is shareholder-oriented<\/strong>.<\/p>\n\n\n\n Having seen how evolving companies can give rise to promising securities, Greenblatt turns to consider the more specialized opportunities that arise when companies are heavily leveraged\u2014in other words, when they take on debt. In this section, we\u2019ll discuss why highly leveraged stub stocks are desirable investments and then examine how long-term equity anticipation securities provide similar benefits to stub stocks. <\/p>\n\n\n\n Stub stocks, Greenblatt clarifies, emerge whenever a company chooses to recapitalize\u2014that is, when it pays shareholders either cash or other securities so it can repurchase large quantities of its own stock. Greenblatt argues that stub stocks provide a favorable investment opportunity <\/strong>because they amplify companies\u2019 increases in earnings while limiting downside risk.<\/p>\n\n\n\n Stub stocks, Greenblatt points out, are a relatively rare phenomenon. However, he writes that you can enjoy similar benefits to stub stocks by investing in long-term equity anticipation securities (LEAPS). According to Greenblatt, LEAPS are another investment vehicle that can yield outsized returns while minimizing downside risk.<\/strong><\/p>\n\n\n\n Like stub stocks, LEAPS can amplify increases in stock price to yield disproportionately large returns. Returning to the previous example, if you purchased 1,000 LEAPS at $1 each that gave you the right to buy Disney at $90 down the line, then you could earn $10 per LEAP if Disney stock rose to $100 per share. Thus, your initial $1,000 investment would return $10,000, a tenfold increase. By contrast, those who owned Disney\u2019s common stock at $90 would earn a meager 11% return on investment in the same period.<\/p>\n","protected":false},"excerpt":{"rendered":" How can you become a stock market genius? If you were to ask a hedge fund manager how to invest, what would they say? In You Can Be a Stock Market Genius, Joel Greenblatt leverages his expertise as a hedge fund manager to inform laypeople about how they can begin investing in the stock market. He focuses on special-situation investing, a type of investing that relies on finding undervalued stocks. Learn more about how you can begin investing with these strategies from You Can Be a Stock Market Genius.<\/p>\n","protected":false},"author":24,"featured_media":45286,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[40,81,31],"tags":[1276],"class_list":["post-114144","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-books","category-economics","category-money","tag-you-can-be-a-stock-market-genius","","tg-column-two"],"yoast_head":"\nJoel Greenblatt\u2019s Approach to Investing<\/h2>\n\n\n\n
What Is Special-Situation Investing?<\/h2>\n\n\n\n
A Brief Introduction to Value Investing<\/h3>\n\n\n\n
How Value Investing Creates a Margin of Safety for Investors<\/h4>\n\n\n\n
Greenblatt\u2019s General Tips for Special-Situation Investors<\/h3>\n\n\n\n
Tip #1: Invest Independently<\/h4>\n\n\n\n
Tip #2: Invest Selectively<\/h4>\n\n\n\n
Tip #3: Don\u2019t Blindly Trust Analysts<\/h4>\n\n\n\n
Investing in \u201cNew\u201d Companies: Spinoffs, Partial Spinoffs, and Orphan Equities<\/h2>\n\n\n\n
How to Profit From Spinoffs<\/h3>\n\n\n\n
How to Profit From Partial Spinoffs<\/h3>\n\n\n\n
How to Profit From Orphan Equities<\/h3>\n\n\n\n
Finding the Best Orphan Equities<\/h4>\n\n\n\n
Investing in Evolving Companies: Acquisitions and Restructurings<\/h2>\n\n\n\n
How to Profit From Companies Undergoing an Acquisition<\/h3>\n\n\n\n
How to Profit From Companies Undergoing a Restructuring<\/h3>\n\n\n\n
Investing in Leveraged Companies: Stub Stocks and LEAPS<\/h2>\n\n\n\n
How to Profit From Stub Stocks<\/h3>\n\n\n\n
How to Profit From LEAPS<\/h3>\n\n\n\n