April 8, 2010

The Value of Corporate Events

I started to realize that hunting for value is a strategy well suited for, mostly, undervalued markets. Generally these situations appear abundant in these markets, therefore increases the odds of positive performance. However, searching for undervalued companies ala Buffett in markets that seemed to be fairly valued is not a strategy I am willing to undertake. I reckon undervalued markets like the one we had in 2008 is like shooting fish in a barrel but otherwise you need to be really a sharpshooter with strong set of skills or a lot of luck to do well.

Off course the obvious alternative is to stay on the sidelines waiting for those undervalued markets, but what if they do not materialize.

successful value investing requires significant diligence. Investing is not hard or rocket science but requires a lot of time and resources to come up with single idea. I reckon, based on my limited experience, to produce a single good idea you have to vet at least 10 with the same intensity and diligence. One of the most critical aspect of investing is generating ideas. Idea generation can't be random it has to be systematic otherwise you will never know what works. It is the pane of my investing existence is how to find those ideas? how to build a pipeline of company to analyse? do you start with A's and work down the alphabet? or do you run screens that will uncover good companies in the past? So needless to say it is important to have a "search technology", as Prof. Greenwald puts it in his book "Value Investing: from Graham to Buffett and beyond".

That is why event driven strategies is what I observed to be the best search strategy for individual investors. It is all about odds. Event driven investing puts the odds slightly in my favour. I get a concrete set of ideas with good probability of out performance. I have been concentrating on two events:
  1. Spin-offs,
  2. Post bankruptcy equity, and
  3. Index Deletion.
For example, spin-offs offer great hunting ground. I do not use spin-offs investing as a blanket approach, although I wish I did I would be better off for it. I need to vet the presence of good business and competitive advantage. Spin-offs will have duds, that's why they are being spun off. However, the odds to pick good performers over the next 3 years are much better than picking from the entire market universe. Most of the time markets fear from the uncertainty of smaller and unproven companies are wildly exaggerated.

From the spin-offs I followed, I have invested in some but not all, it out performed the S&P by 23%. That is not unusual. Most studies find 15-20% out performance for spun off companies. The reasons for the out performance vary from better focus to better information transparency.

There is a busy calender for spin-offs this year, I will post if any seem interesting.


Jae Jun said...

I've been thinking along the same lines and jumped onto the bankruptcy path as of late.

Very interesting and extremely profitable if done right but the odds and hand must be played smartly.

Sami said...

I am learning about bankruptcies. Very tricky area but as you said if you know it yuou have an advantage.

I followed GGP, Lear and Six flags. GGP for the people who took the risk was more than a home run. I evaluated buying at 50cents but let it go.

Lear I did well on.

sixflags waiting for exit to buy the post equity, although it has returned 200%+ in the past few days to rumors about takeover or merger by ceder. I doubt that will happen.

Tony F. said...

Great topic.

“selling without economic reason” treat is also shared by “Dividend suspension”.

Personally I’d love to have a method to compile a list of companies with “honest and capable managers”.
I bet it would be a fertile ground for hunting. I just wonder what FCF figure would ISCA clock, should S. Biglary run the show.