Hi, Welcome to the 11th Special Edition
Brief Overview of What We will cover in this Issue
Detailed Key Takeaways from the book I am reading Currently
4-5 Decent Articles to read
How to apply the DCF Model to New-Age Business
What you should do in a crash if you already invested fully, Contrarian Investing & Mean Reversion, Inflation is good or not!
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You Can Be a Stock Market Genius (Part-2)
Case Study: Lehman Brothers
According to the filings and extensive newspaper accounts, Lehman Brothers had the highest expenses per dollar of revenue in the investment industry, had lost money in the last year, and had an extremely volatile earnings history.
There was a good chance that when it came time to split up profits between employees and shareholders, shareholders would lose
According to newspaper accounts, one problem with American Express had been that large institutional investors had no idea what its earnings were going to be for any given period. The main culprit was Lehman’s volatile earnings track record The only thing Wall Street hates more than bad news is uncertainty. Overcoming the problem of unpredictable earnings was precisely the goal of the Lehman spinoff.
American Express appeared to have a niche in the higher end of the market, with a franchise and brand name that was very hard, if not impossible, to duplicate
After growing at 20 percent per year for such a long time and having a steady income stream from the assets under management, buying this business at a huge discount to the market multiple (of between fourteen and fifteen) seemed like a steal. Although American Express also owned an international bank (most probably worth just ten times earnings), this accounted for less than 10 percent of its total profits.
The bottom line was: At less than ten times earnings, American Express looked very cheap.
As a general rule, even if institutional investors are attracted to a parent company because an undesirable business is being spun off, they will wait until after the spinoff is completed before buying stock in the parent. This practice relieves the institution from having to sell the stock of the unwanted spinoff and removes the risk of the spinoff transaction not being completed.
Often institutional buying of the parent’s stock immediately after a spinoff has a tendency to drive the price up.
That’s why, if the parent company appears to be an attractive investment, it is usually worthwhile to buy stock in the parent before the spinoff takes place. Although it is a little more trouble to“ create” the bargain purchase by buying stock in the parent before the spinoff is completed, it is usually worth the extra effort— even if you don’t get a great price when selling the spinoff shares.
By the way, a little over six months after the spinoff, Warren Buffett announced that he had purchased just under 10 percent of American Express. Apparently, the spinoff and sale of unrelated businesses had unmasked American Express to be a “Warren Buffett” company— a compelling bargain with a strong brand name and an attractive market niche.
I never like to work too hard to understand an investment. So if a potential investment is too complicated or difficult to understand, I’d rather skip
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Partial Spinoffs
Partial spinoffs are so attractive. Here is an area where boning up on first-grade math skills (especially subtraction) is the key to success.
The benefits of investigating partial spinoffs are twofold. First, in the case where shares in the partial spinoff are distributed directly to parent-company shareholders, spinoff shares should perform well for most of the same reasons that 100-percent spinoffs do.
By the way, although I am a strong advocate of doing your own work, this doesn’t mean I’m against “stealing” other people’s ideas. It’s a big world out there. You can’t begin to cover everything yourself. That’s why, if you read about an investment situation that falls into one of the categories covered in this book, it’s often productive to take a closer look.
If either the logic of the situation is compelling or the advice comes from a shortlist of reliable experts (to be named later),“ stealing” can be a profitable practice.
Insiders. I may have already mentioned that looking to see what insiders are doing is a good way to find attractive spinoff opportunities.
But, did you know there are times when insiders may benefit when a spinoff trades at a low price? Did you know there are some situations where insiders come out ahead when you don’t buy stock in a new spinoff? Did you know you could gain a large advantage by spotting these situations? Well, it’s all true.
Insider Tips: A Do It Yourself Guide
The company’s owners want the stock to be sold at a high price so that the most money will be raised. The underwriter will usually prefer a lower price so that investors who buy stock in the offering can make some money. (That way, the next new issue they underwrite will be easier to sell.) In any event, an arms-length negotiation takes place and a price is set. In a spinoff situation, no such discussion takes place.
Instead, shares of a spinoff are distributed directly to parent-company shareholders and the spinoff’s price is left to market forces.
In other words, don’t expect bullish pronouncements or presentations about a new spinoff until a price has been established for management’s incentive stock options. This price can be set after a day of trading, a week, a month, or more.
Sometimes, a management’s silence about the merits of a new spinoff may not be bad news; in some cases, this silence may actually be golden.
While we could review other ways the rights-offering process can result in big spinoff profits, it is more important to remember one simple concept: no matter how a transaction is structured, if you can figure out what’s in it for the insiders, you will have discovered one of the most important keys to selecting the best spinoff opportunities.
Don’t forget to check out the motives of insiders. That point should come through loud and clear.
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Question: How do you make a half-billion dollars in less than two years? Answer: Start with $ 50 million and ask John Malone. He did it.
John Malone, CEO of Tele-Communications, took advantage of the spinoff process to create a situation that proved to be one of the great spinoff opportunities of all time. Anyone who participated in the Liberty Media rights offering, a spinoff from Tele-Communications, was able to earn ten times his initial investment in less than two years.
Liberty wasn’t nearly as bad off as the newspaper summaries made it appear. The pro forma loss of $ 9.77 per share for the most recent nine-month period wasn’t the whole story. The earnings (or lack of earnings) shown in the pro forma statements included the operations of only a very small portion of Liberty’s assets. Since the bulk of Liberty’s assets were made up of equity stakes in other companies, the revenues and earnings of most of these interests were not consolidated into Liberty’s income statement. (These stakes merely appeared on Liberty’s balance sheet at cost.) Even Forbes magazine (which I enjoy reading) completely blew it. CitingLiberty’s low level of revenues and earnings (I guess they didn’t read the SEC filing), Forbes stated, “If you’re a TCI shareholder, pass on the swap [exchanging TCI shares for Liberty shares through the rights offering]. If you’re considering buying Liberty [stock] . . . , don’t chase it.” So, while it’s great to read business publications to find new ideas, it still pays to remember Rule #1: Do your own work.( I’m sorry, but this work does include at least reading the pro forma financial statements.)
→ Spinoffs, in general, beat the market.
→ Picking your spots, within the spinoff universe, can result in even better results than the average spinoff.
→ Certain characteristics point to an exceptional spinoff opportunity: a.Institutions don’t want the spinoff (and not because of the investment merits). b. Insiders want the spinoff. c. A previously hidden investment opportunity is uncovered by the spinoff transaction (e.g., a cheap stock, a great business, a leveraged risk/ reward situation).
→ You can locate and analyze new spinoff prospects by reading the business press and following up with SEC filings.
→ Paying attention to“ parents” can pay off handsomely.
Risk Arbitrage and Merger Securities
Over the last decade, dozens of investment firms and partnerships have entered the risk arbitrage area, once considered a backwater of the securities business. This has made risk arbitrage a very competitive business despite the large volume of mergers. The ability of these firms to follow developments in deals all day long, armed with the advice of antitrust counsel, securities lawyers, and industry-specific investment experts, makes this a very difficult investment strategy for the individual to try at home.
→ The degree of competition keeps the spread between the stock price and the acquisition price relatively low, making risk-adjusted profits tougher to come by.
→ The truth is, things have only continued to get worse in the risk arbitrage business.
→ The risk/ reward issue— the ratio of how much you can lose in a situation to how much you can make— is a much more important factor in determining long-term profitability.
→ The problem with risk arbitrage is, to borrow from Yogi Berra,“ It ain’t over till it’s over.” Too many things have to go right too often.
→ But a streak of bad luck or a macroeconomic event (like a stock-market crash or another oil shock) can send a portfolio filled with risk arbitrage situations plummeting a lot faster, and a lot more permanently, than a portfolio filled with special corporate situations like spinoffs.
Bankruptcy and Restructuring
→ While the securities of companies involved in one stage or another of bankruptcy are often mispriced, that doesn’t necessarily mean all bankruptcy-related securities are cheap.
→ Companies end up in bankruptcy court for all sorts of reasons. A lousy business is only one of them. Some others include mismanagement, overexpansion, government regulation, product liability, and changing industry conditions.
→ It is these attractive but overleveraged situations that create the most interesting investment opportunities.
→ Unfortunately, just because you can buy the bonds, bank debt, and trade claims of bankrupt companies doesn’t mean you should.
How to Profit from Bankruptcy Companies
What if I told you there was a time in the bankruptcy process where all the complicated issues had been resolved? What if I told you there is a readily available public filing that pretty much sums up the outcome of the bankruptcy proceedings— complete with management’s projections for the company’s future operations? What if I told you that there is an opportunity to buy securities from sellers who don’t want them— and never wanted them?
Well, in short, there is a time, it is available, and yes you can. While investing in the securities of a company still in bankruptcy entails all sorts of complications and risks, once a company emerges from bankruptcy, there is often an opportunity to make a new but more familiar kind of investment.
The old shareholders, the investors who owned stock prior to the bankruptcy filing, are usually wiped out entirely or issued a few pennies’ worths of warrants or common stock in the new company.
Your opportunity comes from analyzing the new common stock. Before the stock begins trading, all the information about the bankruptcy proceedings, the company’s past performance, and the new capital structure are readily available in a disclosure statement. This filing is made with the bankruptcy court and can be obtained directly from the individual company, from a private document service (see chapter 7) or, under certain circumstances, from an SEC filing known as a registration statement. The disclosure statement—because it provides management’s future projections for the business—actually contains more information than the registration statement filed for a more typical new stock issue. In short, the past complications of the bankruptcy proceeding are explained while the future (at least management’s best cut at it) is laid out for all to see. Only many of the company’s new shareholders may not care.
Since the new stock is initially issued to banks, former bondholders, and trade creditors, there is ample reason to believe that the new holders of the common stock are not interested in being long-term shareholders. Due to an unfortunate set of circumstances, these former creditors got stuck with an unwanted investment. Consequently, it makes sense that they should be anxious and willing sellers. In fact, a reasonable supposition might be that banks, bond investors, and suppliers have every reason to sell their common stock as soon as possible. While this scenario makes sense and often results in bargain opportunities when it comes to investing in the new stock of formerly bankrupt companies, I am forced to repeat those two invaluable words of advice: Pick your spots. (Note: There are three kinds of people— those who can count and those who can’t.)
If a company’s business were easily salable, in many cases creditors would have forced the sale while the company was still in bankruptcy. The result is that, in many instances, the quality of the companies that do come out of bankruptcy isn’t all that great and the long-term performances of their stocks tend to reflect this fact (though the real basket cases are usually liquidated and never make it out of bankruptcy).
By way of contrast, Wall Street generally ignores the stocks of companies coming out of bankruptcy. No one has a vested interest in promoting them: no commissions; no research reports; no roadshow. That’s why these stocks are sometimes called orphan equities.
There’s another reason an orphan stock may be priced cheaply—a low market value. Smaller situations may not attract vulture investors because these investors can’t establish a big enough position in the bankrupt company’s debt to justify the time and effort involved in doing the necessary research. The same logic applies to research analysts and institutional investors. These situations are truly orphaned and may trade cheaply for some time before they are discovered.
In the end, however, most investors would be best advised to stick to the few companies coming out of bankruptcy that have the attributes of a “good” business—companies with a strong market niche, brand name, franchise, or industry position.
Case Study: Charter Medical (Lesson: Know when to hold and when to exit)
In December 1992, there were several things about the stock of Charter Medical Corporation that looked attractive. Of course, since some months earlier it had emerged from bankruptcy, it was classic orphan equity. The stock, which had initially traded as high as $8 per share and as low as $4.7 5, was trading for just over $7 when it was brought to my attention
It looked to me as though, based on the valuations of the most comparable hospital chains (those with large exposure in the psychiatric area), Charter should be trading closer to $15 rather than the $7 it was trading for when I finally took a look in December 1992.
Charter’s plan was to control costs, to step up marketing for new patients, and to increase its outpatient psychiatric services.
Things went well for Charter over the next year. Costs were contained, patient admissions increased, the outpatient business continued to grow, and the conventional hospitals were sold for a good price. Also, Wall Street discovered Charter Medical— the stock tripled and I was able to sell the stock for a large gain. I may have gotten a little lucky on this one, though. If I had held on after the initial big gain, I wouldn’t have made any money in Charter stock for the next three years. Perhaps there’s a lesson to be learned from this poor subsequent performance.
When to Sell
This is probably as good a time as any to discuss the other half of the investment equation— when to sell. The bad news is that selling actually makes buying look easy— buying when it’s relatively cheap, buying when there’s limited downside, buying when it’s undiscovered, buying when insiders are incentivized, buying when you have an edge, buying when no one else wants it—buying kind of makes sense. But selling— that’s a tough one. When do you sell? The short answer is— Idon’t know. I do, however, have a few tips.
One tip is that figuring out when to sell a stock that has been involved in some sort of extraordinary transaction is a lot easier than knowing when to sell the average stock. That’s because the buying opportunity has a well-defined time frame.
Whether you own a spinoff, merger security, or a stock fresh out of bankruptcy there was a special event that created the buying opportunity. Hopefully, at some point, after the event has transpired, the market will recognize the value that was unmasked by the extraordinary change. Once the market has reacted and/ or the attributes that originally attracted you to the situation become well known, your edge may be substantially lessened. This process can take from a few weeks to a few years. The trigger to sell may be a substantial increase in the stock price or a change in the company’s fundamentals (i.e., the company is doing worse than you thought).
→ the company is an average company in a difficult industry and you bought it because a special corporate event created a bargain opportunity, be prepared to sell it once the stock’s attributes become more widely known.
→ Charter Medical’s case, even though the company’s earnings continued strongly after I bought it, I still kept in mind the difficulty and uncertainty surrounding its main business. The stock price started to reflect positive reports from Wall Street analysts and the popular press, so I sold it. No science. The stock still looked relatively cheap, but Charter was not in a business I felt comfortable investing in over the long term.
→ The bargain created or unmasked by the special corporate event— that’s what draws me in. The quality and nature of the business— that’s what usually determines how long I stay.
→ Whenever you can buy into one of these great new concepts or products through the stock market, there’s usually a price tag that goes along with it. The stock price could be twenty, thirty, or fifty times earnings. In many cases, the price/ earnings ratio could be infinite— in other words, the business is so new, there are no earnings; in the case of “concepts,” there may be no sales, either! My negative attitude toward investing in fast-growing (or potentially fast-growing), high-multiple stocks will probably keep me from investing in the next Microsoft or Wal-Mart. But I figure, since I’m no wizard at forecasting the next big retail or technological trend, I’ll probably miss out on a pile of losers, too. For me, this is a fair tradeoff because (as I’ve pointed out before) if you don’t lose, most of the other alternatives are good.
New-Age Business and High Growth Busines
But wait a second. I already said I don’t feel comfortable investing in these new-concept, high-growth companies. Well, actually, what I really said was— I hate losing money on these things. I’m always worried that paying big multiples to earnings (or sales) based on my own future growth projections could lead to big losses. That’s the kind of investing that makes me uncomfortable.
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→ Bargains are often created by anxious sellers who never wanted the stuff in the first place.
→ if investing in spinoffs is what works best for you, by all means, keep doing it until they cart you away.
→ Investing in this area without a good understanding of how options work is like running through a dynamite factory with a burning match— you may live, but you’re still an idiot.
→ No matter where you choose to get started, keep in mind, that an entire portfolio won’t materialize overnight.
QUESTION: WHERE CAN YOU FIND THESE SPECIAL INVESTMENT OPPORTUNITIES? Answer: Read, read, read.
Though you can find new ideas almost anywhere in the business press. Time and interest are your only constraints.
→ Remember, it’s the quality of your ideas, not the quantity, that will result in the big money. So don’t kill yourself; read when you have time and when you’re in the mood. That way, you’ll end up being much more productive.
→ But remember, you only need one good idea every once in a while.It’s better to do a lot of work on one idea than to do some work on a lot of ideas.
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→ To be a successful investor over the long term, you must also pretty much enjoy the journey. In fact, if you’re not going to enjoy the “game,” don’t bother: there are far more productive uses for your time.
→ if you are able to successfully manage your own investments, there can be some side benefits. While everyone knows what money cant buy, there are obviously things that money can buy: a sense of security, a comfortable retirement, and an ability to provide for your family. Even from a religious standpoint, money doesn’t have to be such a bad thing. In fact, if it’s used to help others, money can be a very positive force.
→ While too many say “time is money,” it’s probably more universal to say that “money is time.” After all, time is the currency of everyone’s life. When it’s spent, the game is over. One of the great benefits of having money is the ability to pursue those great accomplishments that require the gifts of being and time. In fact, you can’t raise a family or make your contribution to society without these gifts. So, while money can’t buy you happiness or even satisfaction, it might buy you something else.
→ As long as the economy and the individual businesses that make it up continue to grow, sooner or later the stock market will reflect this reality. That doesn’t mean that in every period the stock market will provide superior investment returns.
→ It might not be today or tomorrow, but if you do your homework well, the stock market will eventually recognize the inherent value that attracted you to the bargain opportunity in the first place. That’s why, in the end, a disciplined approach to seeking out bargain stocks will pay off.
→ The idea behind this book was to let you know about a snowball sitting on top of a hill, to provide you with a map and enough rope and climbing gear so that you can reach that snowball. Your job— should you choose to accept it— is to nudge it down the hill and make it grow.
Books Recommendations for Understand Income Statement and Balance sheet
Interpretation of Financial Statements by Benjamin Graham, (Favorite of Joel Greenblatt)
Other Good Books to read (Recommended by Joel Greenblatt)
Contrarian Investment Strategies: The Next Generation by David Dreman
The Intelligent Investor: A Book of Practical Counsel by Benjamin Graham,
The Warren Buffett Way: Investment Strategies of the World’s Greatest Investor by Robert Hagstrom
The New Finance: The Case Against Effective Markets by Robert Haugen
One Up on Wall Street and Beating the Street by Peter Lynch and John Rothchild,
The Only Investment Guide You 11 Ever Need by Andrew Tobias,
Excerpts and Learning from Articles/Blogs
Trying Too Hard
Michael Batnick has made the point that having experienced a big event doesn’t necessarily make you better prepared for the next big event.
On the one hand, people that have been investing through the events of 1987, 2000 and 2008 have experienced a lot of different markets. On the other hand, isn’t it possible that this experience can lead to overconfidence? Failing to admit you’re wrong? Anchoring to previous outcomes?
Of course. It happens all the time. The feeling of power you get from hard-fought experience is stronger than the urge to change your mind, even when it’s necessary.
especially service industries where someone pays for an expert’s opinion. There can be a difference between knowing what’s right and making a living delivering what you know to be right.
Vijay Kedia’s take on the market crash
In a bull market beginners become geniuses, advisors, chartists and economists overnight but in a bear market geniuses, advisors, chartists and economists become beginners.
How large is the Indian market for B2C tech businesses in terms of users who can generate revenue?
One Deep Thought For Bad Times
Lux Capital Q1 Letter: Survival is a necessary precondition for growth
Traps to avoid in Promoter buying scenarios.
Small Video Clips
Should you deploy money during a crash from debt to equity if you already have 50:50 Allocation (42:08 to 42:48)
What you should do in a crash if you already invested full and have no cash left to deploy (G Maran) (42:48 To 44:55)
How to apply DCF Model to New-Age Business, Biggest plus point as DIY Retail Investor (Bold take on Paytm Business) (17:05 to 19:58)
Aswath Damodaran on China +1 Story playing out in India (25:55 To 30:13)
Inflation is good or not (47:02 to 50:09)
Learn to ignore these 3 types of Noise (08:08 to 9:31)
Contrarian Investing to succeed in Equity, Invest like Warren Buffett (Watch Full Video) Many old stock name and Important learning)