The book Stock Market Wizards has to rank up there as being one of my favorite all-time books on trading. The entire book is set up as interviews with some famous as well as some unknown trading “wizards.” Throughout each chapter, Schwager extensively questions each trader about their background, their trading style, and most importantly (or most revealing), their biggest failures and successes.

Its got so much information packed into it– over 300 pages long and full of in-depth interviews with trading legends as well as some people you’ve never heard of (who usually run their own money). There are some really interesting people in here, and some pretty big names: Steven Cohen, who runs SAC Capital (one of the biggest hedge funds), generously gives his time to do an interview right from his trading desk; David Shaw, who runs the ultra-secretive D.E. Shaw & Co (a major quant hedge fund), discusses his background in computer science and how it led to his starting a hedge fund. Even a few insights from either of these two guys would be worth the price of the book alone.

Beyond that, however, there are interviews with much less well known traders, one example being Mark Minervini. According to the book, from 1994 through 1999, he had an average compounded annual return of about 220%. Regardless of whether it was a bull market during this period or not, those kinds of numbers are pretty enviable. Again, he goes through some of his stock selection techniques, and how his style has changed over time. Not everyone in the book is a born-and-bred trader. Minervini, as one example, dropped out of college to become a musician. He later realized there wasn’t much opportunity there, and so tried his hand at trading, and was unsuccessful at first. After a decade of research and practice, he finally was able to find success, and now runs his own hedge fund.

Below is a list of some of the traders profiled in this book:

• Ahmet Okumus
• Mark Minervini
• Steve Lescarbeau
• David Shaw
• Steve Cohen

Beyond these relatively well-known traders, Schwager also interviews Dr. Ari Kiev (d. 2009), who worked as a trading psychologist at hedge funds and with individual traders. Kiev has some pretty timeless insight that, again, is worth more than the price of this book.

Application

At the end of the book, Schwager gives a list of 64 characteristics which are found in all or most of the worlds most successful traders. Some of these seem predictable, such as “Hard Work,” or “Failure and Perseverance.” Others, perhaps, are more surprising: “Risk Control,” Successful Investing and Trading Has Nothing To Do With Forecasting,” and “Never, Ever Listen to Other Opinions.” That last one is a key tenet of a Part Time Investor, and I always encourage you to make sure you do your own homework before buying any investment. It’s okay to listen to other opinions, but in the end, you must come to your own conclusions and be able to defend it to someone else. A good way to do this is to pretend that you are a potential client who is possibly going to buy the stock. As a client, you will want to know everything that might possibly be risky or unsuitable about this stock; and it is your job to ask your financial adviser all these questions before you put your money at risk. . Some of the questions might include:

Is this company in a good financial position? Is it anywhere near the risk of insolvency (i.e. bankruptcy)?
Are there any upcoming events which might significantly affect the price of the stock (examples could be earnings statements, a competitor’s launch of a new product, executive officer change, etc.)?
Does the market have strong barriers to entry? Will it be costly for the company to get (stay) ahead?
Is there anything that I’m worried about with this company?
These are just some examples. If you can ask all the relevant questions about a stock, and still be satisfied that it is a safe investment, then it is most likely okay to move on.

If you’re interested in learning more about the day-to-day operations of a hedge fund, then you should read Hedgehogging by Barton Biggs. This relatively recent book (published in 2008) was written by a 30-year finance veteran from Morgan Stanley who then quit to start his own hedge fund. Despite the glorious ideas that most people have about running their own fund, Biggs talks plainly about the challenges and drawbacks of trying to do so. He talks about things you’d expect, like raising funds and going on road shows, but also touches on more serious issues, such as the psychological impact and wear-and-tear that a fund manager faces. He recounts the stories of several personal friends, going through their background, performance, and offers helpful advice from their experiences. A few of the stories are so outlandish as to even be unbelievable (e.g. Chapter 20, see below), but he recognizes that ahead of time, and says so in the chapter opening. Suffice to say, the characters in this book are not lacking in personality.

In general, Hedgehogging is very well written, and offers a ton of insight into the usually secretive world of hedge funds. Biggs has a very informal tone at times, yet his intelligence always shines through. The book is written less in a nonfiction tone, but instead is quite personal and helpful. A possible, but quite understandable, drawback is the fact that most of the names of the characters and funds mentioned have been changed. The lessons some of the interviewees teach are worth more than the cost of this book totally.

Here is a list of the table of contents, taken from Amazon.com:

1. The Triangle Investment Club Dinner: Hacking Through the Hedgehog Jungle
2. The New Hedgehogs May Have Been Golden Boys, but They Still Bleed Red
3. Short Selling Oil: The Crude Joke Was On Us
4. Short Selling Is Not For Sissies
5. The Odyssey of Starting a Hedge Fund: A Desperate, Frantic Adventure
6. The Roadshow Grind: Blood, Sweat, Toil, and Tears
7. The Run-Up and Haunted by Remembrances and Doubt
8. Hedgehogs Come in All Shapes and Sizes
9. The Violence of Secular Market Cycles
10. The Battle for investment Survival: Only Egotists or Fools Try to Pick Tops and Bottoms
11. From One Generation to Another: Bismarck and the Yale Endowment
12. Nature’s Mysticism and Groupthink Stinks
13. The Internet Bubble: I’d Still Rather Have Air-Conditioning
14. Great Investment Managers Are Intense, Disciplined Maniacs
15. You’re Only as Beloved as Your Most Recent Performance
16. Once You Have a Fortune, Can You Hang On To It?
17. Three Investment Religions: Growth, Value, and Agnostic
18. The Trouble with Being Big
19. Bubbles and the True Believer
20. Divine Intervention or Inside Information? A Tale That Will Make You Blood Run Cold
21. John Maynard Keynes: Economist, Hedge-Fund Manager, and Fascinating Character
22. Conclusion and Recommended Reading

If you love learning more about the hedge fund world, either to start your own someday, or simply pick up a little investing advice, Hedgehogging is a great resource. I recommend you check it out!

Overview

With its cheesy and cliché-sounding title, it’s a wonder anyone buys You Can Be a Stock Market Genius after seeing it at Barnes & Noble. The only reason I even ordered it was that it was recommended to me by several people as one of the most valuable investing books for the cost ($5-10). I’ve read and reread it multiple times, and I can’t emphasize enough how great a resource it is.

Although it covers a few topics which are a bit dense for the average investor, if you take the time to read through the entire thing, I can guarantee that you will learn some useful strategies for finding investment opportunities. The main topics covered in his book are spinoffs, rights offerings, risk arbitrage, merger securities, bankruptcies and restructuring, recapitalizations, warrants, and options. If none of those words makes any sense to you, don’t worry! By taking a little time to understand what situations these arise in, you will easily give yourself an advantage over most people who are unwilling to put in the research. Even if you dial in on one single strategy, it will be incredibly helpful.

For the uninitiated, below is a quick summary of each of the terms I’ve mentioned above.

Spinoff

A relatively common event which is exactly like it sounds it would be—a larger company “spins off,” or sells, a subsidiary company to its shareholders or to the general public. The main reason why a company would do this is recognize the intrinsic value of a company that might otherwise be too complicated to assess. For instance, if a large company deals primarily in retailing (think Walmart or JC Penney), but they own a tire manufacturer or even something totally unrelated like an offshore oil prospecting company, it might be hard to value the combined company, since their business models are so different. If the two companies then separate, analysts or investors can more accurately value the new companies. Often times in valuing a company the methods an investor will use might vary based on what industry they are in. Without getting into too much detail on valuation (a post to come on that later), by separating the parent company from the spun off subsidiary, the investing public will now be able to value each company separately, and (hopefully) realize an increased value.

Rights offering

One of the possible methods a company might use to spin off a subsidiary. A rights offering is basically when the parent company gives its current shareholders the right, but not the obligation, to buy the new spinoff shares at a discount to market value. This benefits both the company and the shareholders as the company can raise a little bit of money, while the shareholders can buy the new company at a discount before the rest of the market.

Risk arbitrage

This is essentially a form of gambling on the outcome of a specific deal that was announced in the news. Risk arbitrageurs are those making the bets. When a company announces an acquisition, they usually include the agreed price that they will pay. For instance, in mid August 2010, Blackstone Group (BX on the NYSE) announced that they would acquire Dynegy, Inc. (DYN) for $4.50 a share. On August 12^th, DYN was trading around $2.78 a share. Overnight, the price of the shares catapulted to around $4.50 since the deal was seen as being almost certainly to go through. Without getting into too much detail, there are risks surrounding every deal between companies that might make the deal fizzle or run into problems. Risk arbitrage is betting on the outcome of the deal in the hopes of making a few cents per share if it does or doesn’t go through. The BX-DYN deal has a few special factors which would make it different, but often after a deal is announced, the targeted company trades slightly below the deal value. The difference is the “arbitrage” that some traders try to capitalize on.

Merger securities

Merger securities are a bit complex so I’ll be brief here. They can arise in mergers where the acquiring company wants to use other forms of payment rather than cash or pure stock. Basically, they make the transaction more complicated for various reasons, usually to confuse people and get them to sell the securities (only sort of kidding). An example could be three year, 9% interest convertible bonds with redemption at the company’s choice (exactly).

Bankruptcies and restructuring

Bankruptcies are something everyone knows about. There are two main types of business bankruptcies, Chapter 11 and Chapter 7. Chapter 11 (of the US Bankruptcy Code) is used when a company wants to restructure its business or capital structureand is seeking protection from creditors (those who hold the company’s debt). Chapter 7 is used when a company wants to liquidate its assets to pay off its debt, and then will return whatever is left (if anything) to the shareholders.

When a company files for bankruptcy protection, its public stock is usually removed from the stock markets (delisted), and when it emerges from bankruptcy, it relists its new stock on the market. Often, the stock trades at a depressed value for a period of time, because formerly bankrupt companies are considered undesirable for most average investors’ portfolios. That is where the opportunity lies for those willing to understand the story surrounding a bankruptcy.

Recapitalizations

Generally speaking, to recapitalize is simply to change the capital structure of a company. It can arise in various situations, but anything that the company does to either pay down (or issue more) debt, or issue more (or buy back) equity, is considered a recapitalization. Recapitalizations are used to increase the value of the company’s stock.

Options

Options are somewhat more common, and give the holder the right, but not the obligation, to buy or sell the underlying stock at a given price, at a predetermined time. There are two main types of options: calls and puts. A call is the right to buy a stock, and a put is the right to sell a stock. Options are contracts traded on exchanges between two parties, similar to stocks.

Warrants

Warrants are similar to options except that they are issued directly by the company, whereas options are contractual agreements between two parties in the public market. A three-year warrant to buy Google stock at $600 a share would allow the holder to buy the stock at any time during the next three years from Google directly for $600.

Summary

Despite the seeming complexity of some of the situations and securities described above, Greenblatt’s book really emphasizes that special situations are really not that hard to understand. Most average investors, he argues, are not willing to put in the time to fully learn about a potential investment opportunity. Those that do will therefore have an informational advantage, and will find opportunities that others miss. His book really explains the concepts in a very readable way, and he gives several case studies in each chapter showing what he looked for when analyzing an opportunity, and what mistakes he made too. It is a very valuable read, as I mentioned, and I would highly recommend it to anyone seeking to learn more about special situations investments. One of the core value investing tenets is that you must be willing to do your homework when it comes to finding opportunities. I realize that it might not seem conducive to the part time investor to spend time reading financial statements, but even an hour a day for a few days can help you feel more secure when making a specific investment.

In short: buy this book! It’s well worth the small cost.

Bio of Joel Greenblatt

(per the book’s back cover)

Joel Greenblatt is the founder of the New York-based Gotham Capital, a private investment partnership whose stock portfolio achieved returns of $52 for each $1 invested at its inception, and a former chairman of a Fortune 500 company with more than $1 billion in sales. Greenblatt holds a B.S. and an M.B.A. from the Wharton School. He lives on Long Island and works in Manhatten.