Note: It’s something Warren Buffett wouldn’t look at. Because it’s actually an element of speculation seeping into investing.
A. Low Quality
1. Capital Cycle
Supply falling. Capacity exiting. Capacity utlizations low.
Stock price at a multi-year low.
2. Earnings Rebound
Earnings suddenly improving in a quarter. Example: Metal stocks like Tata Steel and NALCO in FY21Q2.
B. High Quality
3. Earnings Growth
Unusually stable and strong earnings indicate presence of economic moat.
4. Temporary Crisis
Due to geopolitics, macro environment, or corporate scandal. Examples:
- Geopolitics. Covid pandemic. Things had to become normal sooner or later. Retail (TCNS), hospitality (Wonderla, Sinclair) were great buying opportunities.
- Macro environment. 2020 Budget. ITC.
- Corporate scandal. American Express. Nestle India.
Traction becoming evident in scuttlebutt/kicking the tyres.
Example: ITC’s launch of Savlon and Nimwash, ads in IPL 2020.
C. Corporate Events
Triggers provided the companies themselves, and not by stock market participants.
We can group corporate events into 3 buckets – inflow of capital, outflow from capital, and operational:
|Capital Inflow||Capital Outflow||Operational|
|Offer for Sale||Restructuring|
Also, is the fully paid share at a 52-week/multi year low? And coiled-up for a mean reversion? Example: Tata Steel
- Tata Steel Partly Paid. When the price of fully paid shares went up, the partly paids also did.
7. Rights Issue
On listing, share price doesn’t fall to the full extent of dilution.
You get an upside over the rights issue price.
If the company is in F&O, you can also short the share. Which hedges your long position. And you don’t suffer in case the overall market crashes. Hence, you build very large positions.
8. Offer for Sale
5% discount to retail shareholders (holding < 2 lacs). Apply from multiple accounts of relatives.
9. Special Dividend
PSUs. MNCs. Tax treatment of short-term capital loss vs. dividend income.
Key variables are:
- Buyback price
- Acceptance ratio
- Future prospects of the company
11. Open Offer
Key variables are:
- Price on the date of announcement
- Open offer price
- Acceptance ratio: Statutory cap 26% / Minority shareholding %
- Logic: Ratio of market price of the shares vs. swap ratio.
- Some divergence justified. Takes 1 year for approvals.
- Price converges to the swap ratio at the end.
- The acquiring company should be in F&O. So that you can short it. That way, you lock in the arbitrage.
Avoid Merger Arbitrage
- Risk of failure:5Joel Greenblatt, You Can Be a Stock Market Genius, 1999 ed., Ch 4
- Regulatory problems
- Financial problems
- Surprises during due diligence
- Sudden change in business conditions (microeconomic)
- Risk of delay:
- Takes many months
- A key skill in merger arbitrage is to assess the timeline.
- Too much competition
- Sudden crash in stock market or economy (macroeconomic)
13. Merger Securities
Does the purchase consideration in a merger, also include securities?6Greenblatt – Genius – Ch 4
Price appreciation of the demerging, and the demerged company, due to value unlocking.
Future prospects of the demerging, and the demerged company.
Coca Cola restructuring in 1988. Hopefully, ITC.
|↑1||Moneycontrol article on Special Situations|
|↑2||Tata Steel’s Partly Paid Shares, Business Standard, Dec 16, 2020.|
|↑3||SEBI page on rights issues|
|↑4||Three Things to Know about Buybacks, Hindu, March 18, 2017|
|↑5||Joel Greenblatt, You Can Be a Stock Market Genius, 1999 ed., Ch 4|
|↑6||Greenblatt – Genius – Ch 4|