We Study Billionaires - The Investor’s Podcast Network
Episode: TIP677: You Can Be a Stock Market Genius w/ Roger Fan
Release Date: November 22, 2024
Introduction
In Episode TIP677 of We Study Billionaires, hosts Clay Fink and guest Roger Fan delve into Joel Greenblatt's influential book, "You Can Be a Stock Market Genius." Roger Fan, the Chief Investment Officer at RF Capital Management, brings his expertise in special situations investing, shedding light on how Greenblatt's strategies can be effectively applied in today's market.
Joel Greenblatt’s Legacy as an Investor and Author
Roger Fan begins by extolling Joel Greenblatt's remarkable investment track record and his prowess as both an author and educator.
Key Points:
- Greenblatt's hedge fund, Gotham Capital, achieved average annual returns of 40% over two decades without leveraging.
- Author of bestsellers like "The Little Book That Beats the Market" and "You Can Be a Stock Market Genius."
- Renowned for his teaching ability, particularly through his Columbia lecture series.
- Known for identifying and backing successful investment managers, including Michael Burry and Norbert Liu.
Notable Quote:
"He's up there in terms of Mount Rushmore of great investors." – Roger Fan [03:10]
The Appeal of Special Situations Investing
Special situations refer to unique corporate events that can significantly impact a company's valuation, such as spin-offs, mergers, bankruptcies, and restructurings. Greenblatt emphasizes these as prime hunting grounds for mispricings, offering substantial investment opportunities.
Key Points:
- Mispricings occur when the market undervalues certain assets due to complexity or temporary issues.
- Special situations allow investors to capitalize on these inefficiencies by conducting thorough research.
- Greenblatt allocated 80% of his portfolio to special situations, focusing on concentrated positions in a few high-conviction investments.
Notable Quote:
"Half of the game is just investor psychology... the other half is economics." – Roger Fan [07:51]
Understanding Spin-Offs
Spin-offs are a central theme in Greenblatt's investment strategy. A spin-off occurs when a company creates a separate independent company by distributing new shares of an existing part of the business.
Key Insights:
- Performance: Post spin-off, both the new company and the parent often outperform the market. Over a 25-year period, spin-offs outperformed the S&P 500 by 10% annually in the first three years.
- Market Psychology: Institutions often divest from spin-offs due to mandates or non-economic reasons, creating opportunities for private investors.
- Case Study – Host Marriott: A classic example where Greenblatt tripled his investment in just four months by focusing on the spin-off of Host Marriott from Marriott International.
Notable Quote:
"Just do the work that other people aren’t willing to do, you can be rewarded handsomely for that." – Clay Fink [16:05]
Case Study: Host Marriott Spin-Off
The spin-off of Host Marriott from Marriott International serves as a prime illustration of Greenblatt's strategy in action.
Overview:
- Background: In 1992, Marriott announced the spin-off amid a real estate downturn, separating its debt-laden hotel development business (Host Marriott) from its profitable hotel management operations.
- Investment Strategy: Greenblatt invested heavily in Host Marriott, valuing the assets conservatively and leveraging the mispricing for substantial gains.
- Outcome: His investment tripled within four months, demonstrating the power of concentrated positions in special situations.
Notable Quote:
"He sized it up to 40% because that was a situation where basically what he looks for when he puts together a 40% position is that he’s looking for situations where he can't lose money." – Roger Fan [30:28]
Risk Arbitrage and Merger Securities
Risk arbitrage involves betting on the successful completion of mergers or acquisitions, capturing the spread between the current trading price and the acquisition price. Greenblatt differentiates it from traditional risk arbitrage by focusing on merger securities, which offer a safer investment avenue.
Key Insights:
- Opportunities: Regular M&A activity ensures a steady stream of risk arbitrage opportunities.
- Challenges: Increased competition and regulatory risks have made traditional risk arbitrage less lucrative.
- Greenblatt’s Approach: Prefers merger securities over traditional risk arbitrage due to lower risk profiles and higher probability of returns.
Case Study – Loxiton Acquisition:
- Situation: A Hong Kong-listed luxury company, Loxiton, was acquired by a French billionaire with a 6.25% spread.
- Investment Decision: Roger Fan analyzed the deal’s structure, financing, and motivations, concluding it was a favorable opportunity.
- Outcome: The investment yielded an annualized return of 15.7% within five months, validating the strategy.
Notable Quote:
"In general, he doesn’t know why businesses are undervalued. He doesn’t know why he sees situations like Host... he only knows that they exist." – Roger Fan [49:48]
Bankruptcies and Reorganizations
While bankruptcies are typically avoided by most investors due to high risks and complexities, Greenblatt highlights a niche within special situations for those who can navigate post-bankruptcy exits.
Key Insights:
- Risks: High likelihood of equity holders being wiped out; dominance of experienced vulture investors over private investors.
- Greenblatt’s Recommendation: Focus on post-bankruptcy exits, where toxic assets have been cleared, and the company emerges stronger.
- Case Study – General Growth Properties: An example of how strategic investments in post-bankruptcy scenarios can yield significant returns.
Notable Quote:
"If you have the time, if you are a really good investor, you’re good at analyzing information, just put together your own calendar or spreadsheet of all the situations." – Roger Fan [16:43]
Case Study: Kmart’s Restructuring
Eddie Lampert's strategic acquisition and restructuring of Kmart exemplify the potential rewards and complexities of investing in bankruptcies and reorganizations.
Overview:
- Background: Kmart filed for bankruptcy in 2002 due to overstretched diversification and intense competition.
- Eddie Lampert’s Strategy: Lampert employed vulture investing by purchasing significant debt and influencing the bankruptcy proceedings to steer Kmart towards restructuring.
- Outcome: Post-bankruptcy, Kmart's equity surged from $15 to $109 within 18 months, yielding a 229% return.
Notable Quote:
"The estimated recovery range was just 13 to 19%. It was a classic mispriced situation." – Roger Fan [60:12]
Roger Fan’s Investment Philosophy
Roger Fan aligns closely with Greenblatt's concentration strategy, advocating for a focused portfolio with high-conviction positions in special situations.
Key Principles:
- Portfolio Concentration: Typically holds 5 to 10 core holdings, each constituting 5% to 20% of the portfolio based on conviction and risk assessment.
- Selective Engagement: Engages deeply with each investment, conducting thorough due diligence to identify mispricings and catalysts.
- Flexibility: While favoring spin-offs and merger securities, remains open to other special situations like post-bankruptcy exits and restructurings based on opportunity sets.
Notable Quote:
"At RF Capital, we typically have 5 to 10 core holdings and we size up on our positions." – Roger Fan [71:17]
Conclusion
Episode TIP677 offers a comprehensive exploration of Joel Greenblatt's "You Can Be a Stock Market Genius," through the lens of Roger Fan's professional experience. By focusing on special situations—particularly spin-offs, merger securities, and strategic bankruptcies—investors can uncover significant mispricings and generate substantial returns. The conversation underscores the importance of concentration, deep analysis, and understanding market psychology in successfully implementing these strategies.
Final Thoughts:
- Special situations require disciplined research and a willingness to engage in complex investment scenarios.
- Concentrated portfolios, when managed with expertise, can outperform broader indices through strategic positioning.
- Embracing Greenblatt's principles can empower investors to identify and capitalize on unique market opportunities.
Notable Quote:
"If you do the work, you do the valuation work and there’s a gap to intrinsic value and you put on the trade in size, you’re going to do very well." – Roger Fan [49:48]
About Roger Fan
Roger Fan is the Chief Investment Officer at RF Capital Management, where he specializes in special situations investing. With a strong background in value investing and a deep understanding of Joel Greenblatt's strategies, Roger employs a concentrated investment approach to outperform the market. To learn more about Roger Fan and his investment insights, visit rfcapitalmanagement.com or connect with him on LinkedIn and X (formerly Twitter).
This summary is intended for informational purposes only and does not constitute financial advice. Always consult with a professional financial advisor before making investment decisions.