During Greenblatt’s hedge fund days, he held a concentrated portfolio of undervalued stocks and special situations. He goes into detail on special situation investing in his book You Can Be a Stock Market Genius.

Special situations aren’t unique to Greenblatt. Buffett relied on it back in his partnership days. Peter Lynch did too. Klarman does, along with others. Buffett referred to it as workouts and here’s why he relied on it:

“Workouts” – These are the securities with a timetable. They arise from corporate activity – sell-outs, mergers, reorganizations, spin-offs, etc. In this category we are not talking about rumors or “inside information” pertaining to such developments, but to publicly announced activities of this sort. We wait until we can read it in the paper. The risk pertains not primarily to general market behavior (although that is sometimes tied in to a degree), but instead to something upsetting the applecart so that the expected development does not materialize. Such killjoys could include anti-trust or other negative government action, stockholder disapproval, withholding of tax rulings, etc… However, the predictability coupled with a short holding period produces quite decent annual rates of return. This category produces more steady absolute profits from year to year than generals do. In years of market decline, it piles up a big edge for us; during bull markets, it is a drag on performance.

It’s the timetable and what Klarman calls “mindless selling”, which creates mispricing, that makes these so attractive. Continue Reading…