Arbitrage and Special Situations
There are often periods of time when there are no “fat pitches” available for us to invest our cash. Instead of taking a risk on an overpriced stock or one with no moats, we can look for low risk opportunities in arbitrage and special situations.
Arbitrage involves the matching of two assets that creates a risk neutral opportunity for profit. For example, merger arbitrage could involve the purchase of stock in the company being acquired while simultaneously shorting the stock of the acquirer. In most situations today, the market is pretty efficient at analyzing merger opportunities, so the opportunity for small investors to find profit here is pretty small. However, cash offers for small companies can often provide good rates of return, since the big boys might not be interested or able to take advantage of these opportunities.
Special situations involve a large variety of corporate activities such as spinoffs, bankruptcies, liquidations, recapitalizations, and restructurings. As a small investor, I find that cash tender offers for odd lots or for small companies going private offer the best opportunities. Spinoffs can also offer value opportunities, since often major holders of the stock, such as index funds, are required to sell off the shares of the new company they receive.
Warren Buffett took advantage of these opportunities in the early part of his investment career. While many of the opportunities Buffett found might not be available in today’s information age, there are still some opportunities available for the small investor. I’ve listed some resources regarding arbitrage and special situations below. Please let me know of any others that you have found.
Articles
I’ve read a couple of useful articles regarding arbitrage and special situations. FocusInvestor.com provides a good introduction to risk arbitrage. Accompanying that article, there is a useful merger arbitrage model spreadsheet.
Joshua Kennon from About.com Investing for Beginners also has an informative article entitled, “Risk Arbitrage - Profiting from Mergers, Acquisitions and Liquidations“.
Message Boards provide a great source of information on new arbitrage and special situation opportunities. Here are some of my favorites:
- Silicon Investor: Free Money Stocks - This board seems to be the most comprehensive and timely source of odd lot, reverse split, and other tender offers.
- Silicon Investor: SPIN-OFFS “secret hiding places of stock market profits” - This board provides a monthly update of corporate spin-off announcements and transactions in progress.
- VInvesting: Special Situations/Arbitrage Board - The newest board of the group but it is already getting rather active.
- TMF: Zen & the art of risk arbitrage (Subscription required) - Traffic here has slowed down, but some of the earlier posts provide excellent tips.
Researching your own arbitrage and special situation opportunities can be somewhat difficult and time consuming. I’ve pulled together the following list of filings and announcements that might be helpful:
- The Online Investor: Mergers - A good list of the latest merger announcements.
- SEC EDGAR - Search recent filing for opportunities.
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5 Responses to “Arbitrage and Special Situations”
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30 Days to Becoming a Better Investor - Day 28 - Fat Pitch Financials[…] Today’s tip on becoming a better investor comes from deep within my archives. Last year I started exploring investment alternatives when I was having trouble finding value opportunities in wide moat companies. I discovered arbitrage and special situation opportunities. Take a few minutes tonight to explore my initial thoughts on these unique investment opportunities. […]
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Why I Study Warren Buffett - Fat Pitch Financials[…] Those are some pretty amazing numbers. Let’s take a little closer look at the transactions that make up that record. Martin and Puthenpurackal analyzed a total of 261 investments during their study period from 1980 to 2003. The average annualized returns for the stock investments in Berkshire’s portfolio from 1980 to 2003 are an amazing 39.38%. I was somewhat surprised to find out that 59 of those 261 investments could be labeled as arbitrage investments. The average annualized return for the arbitrage stocks was 81.28%! Given that statistic, I now know that I’m not wasting my time pursuing going private transactions and other arbitrage opportunities. “When long-term investment possibilities are limited, Berkshire Hathaway has used risk arbitrage as an alternative to holding short-term cash equivalents. These are arbitrage opportunities that present themselves after an announced corporate event such as sale of the company, merger, recapitalization, reorganization, liquidation, self-tender, etc. The major risk incurred is the risk of the event not happening. Berkshire prefers to engage in only a few large transactions each year because of the effort required to monitor the progress of transactions and the market movements of related stocks .” […]
#1
Congrats on getting this posted on the Carnival.
M&M
#2
Another site that is very useful is http://www.mergerinvesting.com since they have real time profit calculations and merger related news for every announced merger involving a public company in the US at http://www.mergerinvesting.com
#3
If you are someone looking for merger data, you should check out http://www.madmergers.com.