In what is perhaps the worst-titled book in history, Joel Greenblatt’s You Can Be a Stock Market Genius: Uncover the Secret Hiding Places of Stock Market Profits lays the groundwork for the individual investor to profit from special events such as spin-offs, restructurings, risk arbitrage, and merger securities which have long been a profitable playground for sophisticated finance types.  But don’t let the hokey title and light-hearted writing style fool you:  this is a serious investment book, not some get-rich-quick scheme.

Joel Greenblatt is the founder of Gotham Capital, a private investment partnership achieving 50% annual returns over a period of 10 years before closing its doors, so Greenblatt definitely practices what he preaches.  This book was written as a kind of guided tour for how he accomplished such impressive returns.  So far as I know, there are no other books (decent or otherwise) focusing specifically on these kinds of techniques which is unfortunate because this is definitely a topic I would like to learn more on.

Cast Your Line Where The Fish Are

The over-riding theme throughout this book is that if you want big returns, you have to search where nobody else is searching.  In the age of instant quotes and internet research, that is becoming an increasingly difficult task.  In fact, many of Greenblatt’s critics would argue that many of the tips Greenblatt gives here no longer work as well as they used to, if at all, due to increased competition.  They do have a point:  the book was first published in 1999 and a lot has changed since then;  however, Greenblatt addresses the question “will this keep working in the future?” head-on.  His answer is that for some of these techniques, absolutely.  For others, maybe not.

Where To Uncover The Big Profits

In You Can Be A Stock Market Genius, Greenblatt reveals four specific corporate events which tend to hold unusually large profit potential for thoughtful investors. 

1. Spin-offs:Spin-offs usually aren’t all that glamorous.  In fact, spin-offs are often (but not always) the result of a parent company wanting to rid itself of a subsidiary or peripheral division in order to focus on their core business.  Since these non-core divisions are usually neglected (why else would they be spun off to begin with?) they often hold vast potential.  Freed from the inflexibility and lack of proper attention brought on as a result of being part of uninterested corporate juggernaut, a young, talented, and motivated management team can make huge strides in improving profitability surprisingly quickly.  The key to a good spin-off opportunity, Greenblatt explains, is management having skin in the game.  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, specializing in corporate spin-offs can dramatically improve your odds of earning high, sustainable returns in the stock market.  What’s more, the nature of how these spin-offs work in the real world practically guarantees the spin-off niche will be profitable to enterprising investors far into the future.  As always, do your homework.
2. Risk Arbitrage And Merger Securities:  Greenblatt offers a stern warning about the dangers of attempting risk arbitrage (it’s too dangerous for small investors) so we won’t go into that here, but risk arbitrage’s close cousin, the merger security, can offer outstanding profits to careful investors.  Merger securities are generally non-standard, unusual securities originating from deep within the vagaries of merger negotiations, usually as some sort of compromise to get the deal done.  As a result, practically nobody takes the time to understand these securities and even fewer people are interested in owning them.  That gives you, the enterprising investor, a leg up on the competition.  Since these securities are so unpopular, they are nearly always at least a little undervalued.  The key is digging through all the documentation to figure out exactly what these securities are, how they work, and what they are likely to be worth in the future relative to more standard securities such as the common stock or senior debt.  Since literally nobody else is doing this kind of research, you have a huge advantage.
3. Corporate Restructurings:  Most of the time, a corporate restructuring means something went wrong.  Either the company wasn’t performing up to snuff, management is trying to mix things up, or an outright bankruptcy occurred.  Either way, that’s not the type of company you’d want to invest in, right?  Well, probably not the stock.  But many of these companies also issue relatively safe senior debt in a restructuring you can pick up at a significant discount if you know what to look for.  This is definitely an area where you want to pick your spots, though, because the consequence for failure if you’re long is pretty catastrophic.  If you want to dabble in this area but aren’t confident of your skills, there is a decent mutual fund available which deploys a significant portion of its capital in corporate restructurings:  Columbia Value & Restructuring (UMBIX).
4. Stub Stocks, Warrants, Options, and LEAPs:  Derivatives can make good investments, but leverage cuts both ways.  I don’t advocate buying options for investment purposes - only for hedging.  Stub stocks, on the other hand, can make excellent investments.  A stub stock is any stock in which the publicly traded shares represent only a small portion of the overall company.  Usually, the vast majority are owned by another corporation.  Since the majority shareholder is also the controlling shareholder in this case, you can be sure investors’ best interests always come first.  That doesn’t necessarily mean external investors will prosper, but it does increase the odds.  As always, pick your spots here.

You Can Be a Stock Market Genius is the most fun I’ve had reading an investment book in a long time.  Greenblatt’s writing style is refreshingly lighthearted and simple enough even absolute beginners will be able to follow most of what he’s saying.  Even if you never plan on buying an individual security or doing the research necessary to generate the kinds of returns Greenblatt has experienced, his book is still well worth a read for the entertainment value if nothing else.  If you are at all interested in investing, you will enjoy this book. 

If you are willing to work hard and do the research, the information in this book could be your key to huge stock market gains.  This is the exact same stuff all-star hedge fund managers do to generate their eye-popping returns.  It goes without saying that with large profit potential comes large risk, so I advise you to deploy only a small portion of your capital this way if you choose to go down that path.  Good luck!

Buy You Can Be a Stock Market Genius by Joel Greenblatt from Amazon.

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