Investor and author Joel Greenblatt sure comes up with some quirky ways to address investing. In his 2006 book, The Little Book That Beats the Market, he touted a magic formula based on two strong value investing pillars. In his earlier book, You Can Be a Stock Market Genius, published in 1997, the title alone is enough to throw people off. I can, huh? Pull the other one; it's got bells on.
That title sounds absurd because conventional wisdom says that individual investors cannot beat the market or professional investors. In the opening chapters, though, Greenblatt goes to some length to explain why the small investor -- without portfolios totaling hundreds of millions or billions of dollars --has an advantage over professional investors. One, we can stay focused. We don't have to invest in our eightieth or hundredth best idea, but we can stay within our best 10. Two, we can judge ourselves on a much longer time scale than next quarter. Three, we can afford to wait for that fat pitch, that situation that will have an outsized impact on our portfolio.
The rest of the book highlights some of the situations Greenblatt has found in his investing career that can lead to outsized returns. He starts off with a relatively simple area of investing, spinoffs. By looking at several case studies, he shows why investing in this type of corporate restructuring can lead to good things.
The spinoff opportunity
One reason is that the value of the underlying business becomes clearer after it sheds some of its divisions. For instance, in 1992, Sears spun off its Dean Witter (now a part of Morgan Stanley (NYSE: MS ) ) and Allstate (NYSE: ALL ) businesses. Based on the market prices of those two businesses and the market price of Sears itself, one could calculate that the retail business that Sears was back then was priced at only $5 per share, for a business doing $79 per share in sales -- drastically undervalued. It wasn't until the masking effects of Dean Witter and Allstate were removed that the overall market was able see this. Within the next several months, the price of Sears rose 50%.
In an interesting follow-up to the above story, Morgan Stanley is now spinning off Discover (to be listed as NYSE: DFS), obtained with its 1997 merger with Dean Witter, as a separate company on June 30. Those who like Greenblatt's chapter on spinoffs should take note.
Greenblatt then ranges a bit further afield, discussing risk arbitrage and mergers, bankruptcies, warrants and options, and other related areas. While most people have witnessed a spinoff or even experienced one firsthand -- as shareholders of Disney (NYSE: DIS ) recently did -- the other areas discussed in this book are a bit less common. This, Greenblatt feels, is part of their charm; where fewer people play, the chance of a mispriced opportunity is higher.
Not for everyone
Now whether or not the average investor should use these more out-of-the-way types of investing is a topic for debate. But the general lesson holds true -- for potentially high returns, look in areas where others are not and employ a margin of safety.
Despite its tease of a title, this book is not for beginning investors. Not taking the time to learn and understand the situation can lead to poor results. And even then, bad things can happen, as Greenblatt himself admits. For instance, when he discusses the risks inherent in risk arbitrage investing, he writes:
When deals fall apart, it's always unexpected. There's just no point in putting yourself, your money, and your stomach through the hassle. If you still want to run around the house with scissors, go ahead. But there are easier, and safer, ways to make a buck.
You can make a lot of money sticking to the tried and true method of investing long and holding good companies for many years. However, if you are a more experienced investor looking for other areas to invest part of your portfolio in, this book will give you several new places to explore.
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Fool contributor Jim Mueller has just begun to journey away from the safer shores of long-term buy-and-holding by looking at options, but he hasn't stuck his toe in the water yet. Of the companies mentioned, only Disney appears in his portfolio. The Motley Fool's disclosure policy is not as out-of-the-way as you might think.