How To Hack The Stockmarket

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Author: John Bell

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Table of Contents

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Chapter 1 – Introduction

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Chapter 2 – A Primer on the Stock Market

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Chapter 3 – So What is this Loophole?

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Chapter 5 – Why You NEVER Pay a Fair Price

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Chapter 4 – How to Calculate a Fair Price Per Share

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Special Notice

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Chapter 6 – Insider Trading that is Perfectly Legal

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Chapter 8 – Putting it All Together. A Step-By-Step Guide

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Chapter 9 – When to Sell

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Chapter 7 – Real Examples of Loophole Profits

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Bonus Chapter #1 – Risk Free Profits via The 2nd Loophole

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Bonus Chapter #2 – How to Totally Automate ALL of This!

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Chapter 10 – Further Reading

How to Hack the Stock Market

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Special Notice

Before you start reading the report, I need to tell you something important. I’ve recently added a new chapter to the report, it’s right at the end called “Bonus Chapter #2 – How to Totally Automate ALL of This!”.

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Click Here

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The chapter explains a way for you to automate the entire process explained in this report. It’s a weird way for you to make all the profit without any of the hard work. It really is cool and I’d advise you to read the chapter first.


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What’s more you can do it all from the comfort of your home computer or laptop. All you need is an online brokerage account and a live up-to-the minute intraday graph.

This is my first major information product. I am not an accomplished author or speaker, so this product will have some flaws. If you read for style, or for literary quality, like I was saying before, this may not be for you.

However, if you know how to use these simple tools and, you have the ability to focus on the market for approximately one hour each week… There is no limit to the amount of profits you can make.

But there are paragraphs in this report – ideas in this report – whole chapters in “How to Hack the Stock Market” that will have you slapping your thigh and gleefully punching the air above you.

In case you’re skeptical, you needn’t risk a penny in testing it out. Most online brokerages allow you to use a “fake money” account to test your strategies.

Here’s why:

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Every 3 to 4 weeks there is a certain pattern that happens in the U.S. stock market.

Allowing you to watch firsthand as this pattern occurs each and every month – And use this “monopoly money” to place live trades and see for yourself how easy it is.

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I’m not blowing smoke when I say: This report could have you earning thousands of dollars from the stock market - almost immediately after you’ve finished reading it.

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Chapter 1 – Introduction

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This pattern occurs every 3 weeks at most AND it only happens to stocks listed on the NYSE and Nasdaq markets.

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But when you understand this pattern you can buy shares in little-known companies at up to 80% off their true value. Almost religiously after you’ve bought your shares the pattern will reverse. The stock will climb higher and higher - Allowing you to leisurely watch as your money doubles and triples in a matter of weeks. After that – the hardest decision you’ll need to make is when to sell and collect your handsome profit.

Once you’re confident – You can invest as little or as much as you like exploiting this loophole. For example: With just $3,000 to invest you could feasibly generate a $10,000 monthly income. How would an extra $10,000 a month change YOUR life?! Of course, that’s enough to live on and then some. It actually takes me more time to drive to my local bank and get $300 from the ATM than it does to make it using this stock market loophole! Right now... I’m sure you’re skeptical as hell. You may even be thinking to yourself that you have bought the diary of a madman. But let me make you a small promise: Give me a few days.


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– All about the inner workings of the stock market.

You will never be the same again.

It probably sounds boring to you but these dusty old library books literally kept me up at night.

Once you learn what I have to teach you... unless you somehow lose your memory... it will be impossible for you to ever be “ordinary” again.

But despite my intense passion for the stock market it wasn’t until the age of 28 I stumbled on this stock market loophole.

It would be impossible for you to not know how to make tons of money – And it will be impossible for you to forget about what you read.

I was actually working as a janitor at the time and living in rent control housing in California.

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But...

I hope you’ll give me the benefit of the doubt with my promise. If you do, please read on.

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Anyway, before we jump into this thing with both feet... let’s get acquainted. Maybe I should tell you a little bit about myself.

What’s most intriguing about this loophole – Is that no matter how many people follow this technique. No matter how many people I teach it to:

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I was born in Cincinnati, Ohio on March 14th 1978. I grew up with a poor but comfortable upbringing - without a Father.

It will NEVER stop working. The loophole is literally built into the system. Wall Street will never care about plugging this gap because the amounts are too small for them.

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But if you can’t cast-aside your skepticism, please do not waste any more of your time reading any further. Unless you believe in me - “How to Hack the Stock Market” will be worth nothing to you.

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Study this report.


A thousand here, a thousand there – To Wall Street this is like picking up pennies from the curb. To an ex-janitor like me, or a work at home mom – The chapters you are about to read are gold. One more thing...

It was never about the money for me. My intense interest in the stock market was just a manifestation of my Asperger’s syndrome.

I mean it in the most positive way possible.

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I was born with a mild form of Asperger’s syndrome. And this gave me an intense passion for numbers and patterns. At about age 15, this passion evolved into a fascination with the stock market.

I spent years of my life reading copious stacks of library books

It’s just as hard to make $100 using this loophole as it is to make $10,000. I do not mean this in a negative way...

It’s just as hard to turn one dollar into three dollars one hundred times as it is to do it ten thousand times, so why not do it to its fullest? I sure do.


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Chapter 2 – A Primer on the Stock Market

patterns and levels of resistance etc. What’s wrong with this thinking? The stock market wasn’t setup over 100 years ago for shares to be bought and sold based on fictional chart patterns and so called resistance levels. Nobody could even imagine a computer back then, so charting & day trading didn’t even enter their minds as a use for the stock market.

Before we get down to the nuts and bolts of my stock market loophole. I need to give you a quick primer on investing. I’m talking about “real” investing. Not taking punts on a stock because you heard somewhere it’s “hot”.

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Following chart patterns is in my opinion a pseudoscience, and choosing to learn day trading instead of investing is akin to studying acupuncture instead of medicine.

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Although I do want you to do one thing.

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Suspend your belief that other investors are smarter or more intelligent than yourself. You may not believe it right now, but just open your mind to the possibility that Wall Street is not as smart as they’d like you to think.

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Stocks are not wiggly lines.

Most investors (and especially traders) think of stocks as wiggly lines on a chart. And these lines could wiggle upwards or they could wiggle downwards. To them a stock is an electronic price quote and the price is all that matters. This fuzzy thinking is mostly true of day traders. The types who try and predict if a stock will go up by plotting chart

When you buy a stock you’re actually buying a fractional ownership of the underlying business. You’re buying the income stream, you’re buying the assets and you’re taking on the debt.

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In the next few pages I’m going to explain a mindset with which to view the stock market. Don’t worry; this isn’t some Tony Robbins-esque motivational thing. I’m not going to ask you to chant along with me, or “believe in yourself”.

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Investing in a stock because a friend or uncle told you to is pure folly. Likewise investing because a hot stock is about to split, or because you liked the story is also a mistake.

This may sound obvious but think about what this means. Whenever you’re buying stock you should imagine you’re in fact buying the entire company. My point is a billionaire investor wouldn’t buy an entire company because he heard it was hot, or the chart pattern told him to – He would buy an entire company because: • He believed earnings will continue growing giving him a high return on his investment. Therefore if Mr. Billionaire paid a 10x multiple on today’s earnings, he estimates he can sell in 5 years at the same 10x multiple of much higher earnings.

• Or his reason may not be based on earnings; it may be based on the company’s assets. Maybe the company has 15 factories on the books valued at $20 Million. Because


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of historical cost accounting assets are never marked up in value (even real estate). So if these factories were bought in 1902, they could be worth $700m by now – a huge hidden asset Wall Street has missed.

Union Book Company. (UBC)

Union Book Company. (UBC)

Digital Books Corp. (DBC)

Cash: $250 Million

Cash: $50 Million

Total Debt: $200 Million

Total Debt: $200 Million

Net Income: $10 Million

Net Income: $10 Million

Market Cap: $100 Million

Market Cap: $100 Million

Real Earnings Yield: 20%

Real Earnings Yield: 4%

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The market cap of a company is the price per share x total number of shares. i.e. it’s the price of the entire company. So UBC and DBC cost exactly the same amount, right? Both have a market cap of $100m which makes sense considering they both earn $10m per year.

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It just so happens: both these companies earn $10 million per year and both have $200 million of debt. The only difference between the two is the cash balance. UBC has $250 million of cash on hand whereas DBC has only $50 million.

Real Cost: $250 Million

Here’s why that’s such a big mistake.

Let me give you an entirely possible (and actually quite common) scenario. Imagine two companies trade on the stock market, Union Book Company and Digital Books Corp.

On the other hand Digital Books Corp is viewed as new and exciting. Setup 3 years ago they sell digital books online mainly to young, switched on customers.

Real Cost: $50 Million

Most investors wouldn’t take the cash balance into account. They’re too busy plotting a chart, or getting swept up in the romance of Digital Book Corp’s impressive business plan and growth projections.

Most “at home” investors don’t even look at what they receive in return for their money. They probably barely glance at the assets, liabilities and earnings stream they buy – All because they view their stock as a fast moving price quote instead of ownership in a real, live business.

UBC is viewed as a relic of old. This company was formed in 1937 and plods along each year selling books from their direct mail catalog mainly to mature customers aged 50+.

Digital Books Corp. (DBC)

This would give you an earnings yield of 10%. i.e. if you bought the entire company for $100 million you’d be paid $10 million per year. The problem is this common assumption is wrong. Union Book Company really costs just $50 million; On the other hand Digital Books Corp costs a very real $250 million. This gives Union Book Company an even juicier 20% earnings yield, and Digital Books Corp a 4% yield (Less than you can get from a risk free U.S. government bond). How so? Because whether buying one share, or an entire company you receive a proportionate ownership of their assets, debt and earnings stream.


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If you bought the entire Union Book Company for $100 million you could immediately use their $250 million in cash to pay off the entire $200 million debt. And you’d still have $50m in cash leftover. Since you own the entire company you can take this money and pocket it.

My point with all this? You cannot make money in the stock market treating shares as flashing price quotes. The companies are real and your share of the company is real. You wouldn’t buy a local restaurant without glancing at the books. But this happens every day in the stock market when day traders invest based on the pattern of a wiggling line.

E.g. Union Book Company’s Net Debt = +$50m

Billionaire investors like Warren Buffett consistently buy stocks like Union Book Company. Stocks where the profit is made before they’ve sold any shares. Because…

You can probably see where I’m going with this.

Here’s another way of putting it:

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E.g. Digital Book Corp’s Net Debt = -$150m

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Which means you didn’t really buy the entire company for $100 million like you thought, your real cost was $250 million – Because you took on $150m in debt as soon as you acquired it. Leaving you with a rather undesirable 4% earnings yield.

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Price is what you pay. Value is what you get.

Sure when you buy shares in a company you aren’t personally held accountable for the debt. When buying shares you can never lose more than you invest. But this doesn’t mean you can ignore a company’s assets and liabilities. After all the company’s debt repayments will affect future earnings and your share of those earnings.

Imagine two men, one in Columbus, Ohio (Dave) and one in New Jersey (Adam). Both Dave and Adam are newlyweds starting a family and need a new, cheap second hand car. Both happen to find a car they like, and it just so happens the cars cost exactly the same amount ($4,000).

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Digital Books Corp has net debt of -$150 million ($50m cash $200m debt). Which means if you bought the entire company for $100m, then used the $50m in cash to pay off debt – You’re still left with $150m in debt.

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Instead of spending $100 million on buying Union Book Company you’ve in fact spent just $50 million, because the company was cash rich. And you have a steady $10 million per year income stream giving you an earnings yield of 20% on your investment.

We can all agree $4,000 is the price (or sticker price) of each car. But what Adam or Dave receives in exchange for their $4,000 can be drastically different. In New Jersey, Adam visited a local second hand car dealer. The sleazy hotshot salesman sold Adam a car he picked up at auction just a week earlier for $1500. The car is a mess. It was involved in a collision and put back together at some point. Of course, Adam wasn’t told about this – He was in awe of this fast talking, sharply dressed salesman. Meanwhile Dave bought a $4000 car from his neighbor. The


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neighbor, an elderly man had bought the car just a year earlier for $8000 but had suddenly run into financial problems and needed cash fast. He sold this fine car at a knock down price and accepted the loss. His loss was of course Dave’s gain.

more sensible 10x or 11x earnings. The Only Universal Truth

But the VALUE was much different. You cannot put an exact amount on value because it isn’t written anywhere and the figure is subjective. But it’s plain to see Dave got much more than $4,000 in value while Adam received much less than $4000 in value.

In the short-term stocks can sell at any price (cheap, fair or expensive). But in the long-term the price always moves towards fair (where value roughly equals price). In the long term (1 – 3 years) the stock market is efficient, in the short term it can be hugely inefficient.

This same thing happens in the stock market every day. Companies with exciting stories (like bio-technology) sell at sticker prices well above their true value.

To use the same analogy. The same can be said about the second hand car market. Say you want to buy a 2006 Ford Mustang. At any point in time there will be some 2006 Mustangs selling very cheap, some very over-priced BUT on average, most 2006 Mustangs will sell at a fair price.

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You’ see, every company trading on the stock market has an “intrinsic value” – Nobody knows what this exact value is because companies are complex ‘machines’ with thousands of variables.

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Meanwhile boring & stoic companies like manufacturers sell at sticker prices well below their true value.

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In both cases the sticker price was the same - $4,000.

This is the only point I’m going to need you to accept a universal truth. Here it is:

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But, right now there will be hundreds of stocks trading at 50% or less of their true value. In other words dollar bills selling for 50 cents. And you’re much more likely to find these 50cent dollars amongst the boring and unloved than the exciting stocks Wall Street loves. But I hear you ask, if boring companies are always valued at say 7x earnings while exciting companies are always valued at, say 20x earnings – How can I realize a profit on the difference, how can I sell my shares in a boring business for a

The market for second hand cars as a whole (the market’s fictional hive mind) will have a fair price in mind for a good condition 2006 Mustang. But there will always be outliers. The elderly neighbor selling in a hurry or the sleazy salesman squeezing out every last dollar. Likewise most stocks sell at a fair price. Your job is finding the outliers. The one’s selling very cheap. Most often (like the elderly neighbor) these cheap stocks are neither sexy nor exciting. Funeral homes, tobacco processors, DIY megastores etc. As opposed to the fast & exciting new bio-tech with a miracle patent on the brink of curing cancer. It has no revenues, let alone profits – But just think of the possibilities!


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One you’ve bought shares in what you consider a fifty-cent dollar you hold onto the shares and wait. And you’ll only consider selling when they eventually reach your estimate of a fair price.

At other times, his mood goes south and all he sees is a dismal future for the company. He arrives dejected and pale, tie loose around his neck. He is so concerned, he is willing to sell you his part of the company for far less than it is worth. All the while, the underlying value of the company may not have changed - just Mr. Market’s mood.

But it’s not always plane sailing. Sometimes after you’ve bought a stock it can drop – no matter how cheap it is.

Mr Market.

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Now, just in case a few of you still haven’t “got it”. I’m going to explain it yet another way.

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If you liked it at $6 you should love it at $4. And if you have no more money to invest, you just sit tight and wait for the market to crawl up to a more sensible $10 - $13 per share.

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Imagine you are partners in a private business with a man named Mr. Market. Each day, he comes to your office or home and offers to buy your interest in the company or sell you his (the choice is yours).

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The catch is, Mr. Market is an emotional wreck. At times, he suffers from excessive highs and at others, suicidal lows. When he is on one of his manic highs, his offering price for the business is high as well, because everything in his world at the time is cheery. His outlook for the company is wonderful, so he is only willing to sell you his stake in the company at a premium.

The best part of this entire arrangement: you are free to ignore him if you don’t like his price. The next day, he’ll show up at your door with a new one. For your interest, the more manicdepressive he is, the more opportunity you will have to take advantage of him (don’t worry, he doesn’t have feelings or mind being taken advantage of.) As long as you have a strong conviction of what the company is really worth, you will be able to look at Mr. Market’s offers and reject or accept them... the choice is yours.

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Let’s say you value a stock at $13 per share. If after you’ve bought this stock at say, $6 it suddenly falls to $4 you do not sell in a panic induced haze. You should in fact be happy; the market has offered you more “$13 bills” for the even bigger bargain price of $4 each.

This is exactly how you should look at the stock market each share that is traded is merely a part of a business. Each morning, when you open up the newspaper or turn on CNBC, you can find Mr. Market’s prices. It is your choice whether or not to act on them and buy or sell. If you find a company that he is offering for less than it is worth, take advantage of him and buy as much as you want. Surely enough, as long as the company is fundamentally sound, one day he will come back under the sway of a manic high and offer to buy the same company from you for a much higher price. By thinking of stock prices in this way - as mere quotes from an emotionally unstable business partner - you are free from the emotional attachment most investors feel toward rising and falling stock prices.


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Before long, when you are looking to buy stock you will welcome falling prices. The only time you want to invite high stock prices is when you are eager to sell your shares for some reason. Thankfully, in most cases (except those caused by “Life”), you are free to wait out Mr. Market’s emotional roller coaster until he offers a price that you consider equal to or higher than true value of your shares.

inept management who will squander the money (overpriced acquisitions being the biggest culprit). However dividends are good for providing a floor on a stock price. Notwithstanding some big accounting scandal a healthy dividend will keep a stock above a certain level. On the other hand a big dividend is a message from management that they don’t believe they can invest excess cash at good rates of return. Instead they’re giving the money back to shareholders so it can be invested elsewhere. This is often indication of a company late in its life.

This mindset is your greatest advantage in investing.

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They can be forgiven for thinking this. During the first half of the twentieth century, Wall Street believed that companies existed primarily to pay dividends to shareholders. The past fifty years, however, have witnessed the acceptance of the more sophisticated notion that the profits not paid out as dividends that are reinvested in the business also increase shareholder wealth.

In short: Whether you own one solitary share or the entire company - earnings are earnings. At the end of the year you’re richer because the company made an economic profit, not because you cashed your dividend check.

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There’s one other thing I need to address. The fallacy of dividends. When telling friends or family you live off your investments they’ll often say something like “so you own dividend stocks”. Uninformed investors believe receiving a dividend is “something extra” a freebie.

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The Dividend Fallacy

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Profits not paid out can be used for expanding the company’s operations through organic growth and acquisitions or strengthening the shareholder’s position through debt reduction or share repurchase programs. Whether a company you’re invested in pays out 80% of earnings as a huge dividend each year or retains all earnings to be reinvested. In real terms, you’re no better off either way as long as the company doesn’t have egotistical or

Lesson Over

Now, you have a burning question. I can tell. Let me take a guess. You’re thinking if it really is this easy to make money in the stock market. Why isn’t everyone doing this, surely the Harvard MBA types on Wall Street with the 180 IQ’s would know about this and any profit would have been “competed away”. After all, Wall Street is a cut throat industry. Where the smartest whizz kids are hired straight from college, and provided with teams of analysts, research and computing power. What would be left for little old you and me with a laptop computer and pocket calculator?


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Oh, ye of little faith. Read on down to Chapter 3 where I explain exactly why Wall Street MBA types are not competing for these easy profits and why in fact they’re the ones you’re “stealing” from!


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Chapter 3 – So What is this Loophole?

However, interestingly the reverse is also true. Company’s Wall Street is “bored of” are sold at levels far below what a rational businessman would pay. It’s been like this pretty much since the stock market was created, at any one time something is “in vogue” and something else is not. When buying into a hot stock, Wall Street wants you to swap your cash for something worth much less. A pipe dream that the stock you buy will be the next Microsoft or Google. It could happen, but crossing your fingers and hoping is far from a surefire way of getting rich.

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So we’ve established that the way to consistently make money in the stock market is by buying bargains. Accepting this simple logic makes you what is known on Wall Street as a “Contrarian Investor”, someone who makes investment decisions based on their own sound reasoning rather than following the herd.

No. Instead you need a plan. … A methodical and logical strategy you can follow. There will be no “I’ve hit the jackpot” moments - Your successes will be small and consistent with as few capital losses as humanly possible.

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The crazy thing though, is that only in the world of Wall Street is “getting a good deal” seen as unusual and strange.

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In the world of private business, companies too are bought and sold each day. With no Wall Street analysts, research departments and hedge funds. Decisions on the pricing of companies are far more rational.

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Forget the stock market for just a moment.

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Buyers of private companies want a good deal. They want to see a solid business with a good record of earnings, they want a lot of liquid assets and as little debt as possible.

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But the critical point is that buyers of private businesses also want to pay a fair price (at most). Likewise sellers of private businesses are willing to accept a fair price. However, suddenly once a company becomes a public entity with a catchy four letter ticker symbol. As long as it has a hot story to tell (dot com companies, gene splicing biotech’s etc.) they’re sold to investors at prices many times the amount a rational businessman would pay.

If Wall Street is one big casino, I’m about to teach you how to count cards. Let’s get down to it. The Loophole So the aim of the game is swapping every dollar you invest for something worth more than a dollar. You won’t know exactly how much more – But you only need to be approximately right. You don’t need scales to tell you a 300lb man is overweight, likewise you don’t need any special tools or experience to spot the absolute stock market bargains we’re looking for. Now, you can find these bargains anywhere. Every stock throughout a 52-week period will swing from massively


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overpriced to massively cheap. You can see evidence of this in the 52-week range of any stock you care to punch into Yahoo Finance. It’s not unusual for a stock worth $60 per share to swing from $30 to $90 over the course of the year.

per year in their first 3 years after being spun-off. (* Patrick J Cusatis, James A. Miles, and J. Randall Woolridge, “Restructuring Through Spinoffs,” Journal of Financial Economics 33 1993.)

But the loophole makes it easier. Much easier.

What does this mean?

The loophole is a specific area of the stock market where bargains are plentiful. It is a flaw, practically built into the system which pushes stocks to prices far below their true worth. At prices the layman can tell is extremely cheap.

Spin-off Stocks

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The area of the stock market I’m talking about is in corporate refuse. A spin-off transaction is when a publicly traded company wants rid of a (usually much smaller) subsidiary company.

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The subsidiary company becomes a public company in its own right and shares of this new company are distributed to the parent company’s existing shareholders.

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There are many reasons why company’s spin off their subsidiaries, but there is only one reason to care: These spin-off stocks consistently make bagful’s of cash for shrewd investors. One study at Penn State*, covering a 25 year period ending in 1988, found that stocks of spin-off companies on average outperform their peers and the S&P 500 by about 10 percent

But, if instead of buying a random selection of S&P 500 stocks you buy a random selection of freshly spun-off stocks. The study shows you’ll outperform the S&P 500 by 10% per year. Which means instead of making a 10% per year return, just buying random spin-offs could see you earning a 20% average return.

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These bargain stocks only come about once or twice a month at most, and no alarm bells will ring to tell you where these stocks are or when to buy them. You can view searching for these bargains like looking for buried treasure, it’ll take some hard work, but the thrill is in searching for them.

Over the long term the market averages (like the S&P 500) return roughly 10% per year. In other words if you bought 30 random stocks on the S&P 500, over 10 years or so you’re likely to make a return of 10% per year.

And just in case you’re thinking 20% isn’t enough. It is. Warren Buffett is the world’s richest billionaire because he is able to compound his wealth at a rate of 28% every year. Put it this way, imagine you invested $10,000 in a basket of spin-off stocks today. And every 3 years you sell those spinoffs and buy a new selection of spin-offs. As we’ve shown you should earn roughly a 20% average yearly return. $10,000 earning a 20% return each year will be worth $383,376 by the end of year 20! A Chimp Throwing Darts So gather a list of all the spin-off stocks and write each down


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on a piece of paper. Then (this bit’s important) pin them to a dartboard. An untrained chimp throwing darts should be able to pick a selection of stocks that will earn a 20% yearly return.

discount accounting for the forced purchase of an unwanted insurance company.

• Getting rid of a dog: Sometimes management consider the spin-off a “bad” business. They’ll see the spin-off as a way of ridding the unfettered good business from the bad. (A side benefit is that management focused on the “bad” spin-off, with appropriate incentives has a good chance of turning the ship around.)

Not bad. But what if instead of picking random spin-off stocks you do a little work. You take at least a cautionary glance at their earnings, assets and debts. What if you remove the ones with unserviceable debt loads and those making losses?

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• Load the dog with debt: Sometimes management will sneakily spin-off a “bad” business and load the balance sheet with as much debt as it can handle. In this way debt is shifted from the parent to the spin-off directly creating shareholder value for the parent. Every $1 of debt handed to the spin-off is $1 of value for the parent.

Hmm, Tell Me More

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To understand how and why spin-off stocks make so much money. You need to know a few basics.

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At a 30% average return your $10,000 investment is worth $1.9 Million by year 20!

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It’s feasible (and entirely possible) that by removing the bad apples instead of making a 20% average return, you could instead make a 25% or even 30% yearly return.

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We’ll start with why stocks are spun-off in the first place. The reasons are diverse, but all are straightforward and perfectly logical.

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• Unrelated businesses: A steel and insurance conglomerate can spin-off the insurance company into its own public entity. This will allow investors to invest in either the insurance or steel company but not both. All other things equal the stock market will assign a higher value to the businesses separately than together. Why? Because prior to the spin-off investors in the steel industry may still buy the conglomerate but want it at a

• A tax-free dividend: Occasionally management may want to reward shareholders with a large cash distribution. The problem is this dividend will invariably incur a large tax expense. One way of rewarding shareholders without forcing a tax expense is spinning off a subsidiary company. Shareholders who want the cash can sell their shares in the subsidiary, everyone else can hold. • A quick solution to antitrust issues: In a takeover sometimes the acquirer doesn’t want to or can’t (for legal reasons) own a certain business. The solution, which allows the takeover to go ahead, is to spin-off the problem subsidiary to the target company’s shareholders. I could keep on going, but you get the point. Spin-offs happen for a variety of reasons. But the one common thread is that recently spun-off stocks handily outperform the market. Why is this? And…


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Why Will this Loophole Never Close?

“We expect that some First American shareholders, including possibly some of its larger shareholders, will sell the shares of our common stock received in the distribution because, among other reasons, our business profile or market capitalization as an independent, publicly traded company does not fit their investment objectives. Moreover, index funds tied to the Standard & Poor’s 500 Index and other indices hold First American common shares. Unless we are included in these indices from the date of the distribution, these index funds will be required to sell shares of our common stock that they receive in the distribution.”

Luckily for you and me, these stock market profits are practically built into the system. Generally stock in the new spin-off is given to shareholders in the parent company. These shareholders were (for the most part) investing in the parent not the smaller subsidiary. Most investors had probably never heard of the subsidiary until told.

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(Remember I told you, you won’t be competing for these easy profits with stock market pro’s on Wall Street? Here’s why.)

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Most of the time the spin-off subsidiary represents only 10 or 20 percent the size of the parent company. Even if a pension or mutual fund took the time to analyze the spin-off companies prospects. Often the size of the spin-off is too small for an institutional portfolio, it is actually against the law for them to hold onto shares of the relatively tiny spin-off. When First American Financial was spun off from First American Co. they included this paragraph in their Form 10 to explain the situation to investors:

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Supply & Demand

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Subsequently FAF dropped from $19.42 a share to just $12.31 during the first two weeks of selling pressure. The reason is:

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The initial excess supply of shares being sold has a predictable effect on the stock price. It bombs. And it’s not just weekend investors who indiscriminately sell their shares, supposedly shrewd investors on Wall Street are even more predisposed to immediately selling their shares.

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Therefore once the spin-off’s stock lands in the parent company shareholders brokerage accounts it is usually immediately sold on the open market. Importantly it is sold without regard for the underlying value of the spin-off company.

What results from a spin-off distribution is a massive supply & demand imbalance. Almost all of the large institutional investors will immediately start dumping their shares on the market. Furthermore you can couple this with the confused individual investor who’d much rather just sell his newfound shares than look into what actually happened. On the other side of the table, who is making up the “Demand” side of the equation? Not many. Remember while a lot of these spin-off companies are profitable (some hugely so) they are almost always boring, unsexy businesses. Wall Street doesn’t care about them, they won’t be plastered all over the business press – They’re corporate refuse,


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spun-off precisely because they’re unloved and unwanted.

In essence these spin-off stocks are the polar opposite of the hot IPO. Boring rather than exciting and huge excess supply rather than huge excess demand. Pension funds sell their shares, mutual funds sell their shares, individuals sell their shares, index funds sell their shares… And the price almost always plummets.

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Supply towers far over demand, after all:

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Once you’re convinced hunting for stock market super-bargains in the shadowy corner of corporate refuse is a good idea. You’ll want to know how exactly to tilt the odds even more in your favor. How to avoid the inevitable bad apples, and carefully pick the best of the best in order to maximize your return.

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Picking Your Spots

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There is just a few oddball buyers like you and me scooping up as many of these bargain shares as we can buy. It’s fairly common for a spin-off stock to start trading at, say $13 per share and plummet to just $4 to $5 within a few months.

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In Chapter 7, I show real examples of spin-off bargains. This is followed by Chapter 8 where I show, step-by-step with screenshots exactly how to use the internet to find spin-off stocks. But first, I need to teach you my method of putting a “fair price” on any stock. Once you know a stock’s fair price, deciding whether or not to buy is easy.


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Chapter 4 – How to Calculate a Fair Price Per Share

The academics are correct, every business has a “true value” and a discounted cash flow is the ideal method of calculating this true value. But there is one problem. The output of the discounted cash flow model (in this case Y) is only as accurate as the figures used in the model. Calculating a company’s earnings for the next 20 years is hard, very hard. Presumably unless you’re valuing a bond (in which case DCF is perfect) most companies grow their earnings each year.

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We need an easy, objective way of assigning a dollar value to any stock you come across. It may sound easy, but this is in fact a hard undertaking. I’m going to show you a “shortcut method” of assigning a very rough value to any stock.

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All investment errors come from miscalculating the value of the security you’re buying. If you somehow knew the exact value of every share that trades… You could become very rich, very fast by simply buying stocks where the discount from true worth is largest.

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Put another way, this is ‘the trick’.

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If you can spend 5 minutes calculating a fair price per share, the decision to buy is simply checking to see if the current price per share is at a 40% or better discount.

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Let’s begin:

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Many academics profess you should use what is called a discounted cash flow model to calculate the true value of an investment. A discounted cash flow model is simply a forecast of all the profit that can be taken from a business for the remainder of its life. This profit (X) is then discounted by the rate of inflation back to what it is worth in today’s dollars (Y). If Y is $450 million then buying the business at any less than $450 million will result in a profit.

Assuming a conservative level of growth, say 8% per year. A company currently earning $20,000,000 per year will be earning $58,743,872 by year 15. Meaning a majority of the ultimate value of the company will be earnings from later years (i.e. years 15 through 20). So what’s the problem? The problem is that I don’t know anyone who can predict anything 20 years out. Manufacturers of personal cassette players and pagers were probably very happy 20 years ago and predicting great growth in unit sales – A lot can happen in 5 years, never mind 20. I’m not saying discounted cash flows are useless, far from it. But they’re most useful when valuing very stable businesses of which you have intimate knowledge. Companies such as CocaCola that have one product, which they have sold for over 100 years and rarely encounter operating problems. So What’s the Answer? I’ll warn you now, the answer is not perfect.


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No one can ever truly know the value of a company, you can only take a ‘best guess’ approach. But if you form a portfolio of 30 stocks. And before buying each stock you guesstimated their value, and only bought at a 40% or better discount to this value…

Wall Street because it is an instantly identifiable “price” of a stock. This is the simplest method of seeing how cheap a stock is. You can punch in the symbol of any stock on Yahoo Finance and instantly see the P/E (price to earnings) multiple. In general, a multiple of 5 is very cheap while a multiple of 30 is very expensive.

Some of the stocks will be rotten apples, one or two may even go bankrupt and you’ll lose every cent. But on the other hand some will explode in value, maybe even becoming industry leaders and Wall Street darlings.

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(Side Note: A Price-to-Earnings multiple can be flipped round into an earnings yield. A $10 stock earning $1/year has an earnings yield of 10%. It also has a P/E ratio of 10.)

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My idea is simple, if something’s cheap you don’t need a complex computer model to tell you so. An experienced antique dealer can spot a bargain at a flea market instantly. Likewise when you’re grocery shopping, the good deals are obvious.

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It’s no different with stocks. If you need a computer model to tell you something is massively cheap – You’re probably trying to justify the unjustifiable.

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When you see a cheap stock, and I mean real cheap – The numbers will slap you in the face. The easiest way to value a stock is to put a multiple on the earnings the company generates. If a $10 stock earns $1 per share it sells at a 10x Price-to-Earnings multiple. You’ve probably heard of the P/E multiple before, it is widely used in

As always though, there is a problem. The price-to-earnings ratio ignores assets and liabilities entirely. The counter to this argument is that earnings are a function of assets and therefore counting the value of assets and earnings twice is double counting.

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How to Value Any Stock:

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The bottom line is that you don’t know what the future brings. But by owning a diversified basket of stock market bargains your winners will offset losers and your gains will come from both standard earnings growth & your shares rising to their true value.

I agree. But the P/E ratio also ignores debt. And as we saw in Chapter 2, this is a big mistake. Occasionally in bankruptcy, what was once a multi-billion dollar company will sell for the princely sum of $1. The one dollar is just a token amount because the real cost of the business is the assumed debt. If the company has $15 billion in debt (and no cash) the real cost to the new buyer is $15,000,000,001. However if the company selling for $1 has $15 billion in debt and $5 billion in cash. The real cost to the new buyer is $10,000,000,001. In other words the real cost of any company is:


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Purchase Price + Debt – Cash

stockmarketfree.limitediscounts.info during the reporting period.

Many professional investors on Wall Street still make multimillion dollar decisions based on the price of a stock being just the market capitalization (purchase price). You know better.

What’s worse, GAAP accounting standards (under which all US public companies operate) have some rather unusual rules. They use what is known as “accrual basis accounting” as opposed to “cash basis accounting”.

So what can we do with this knowledge? It can be used as a more accurate version of “Price” in the numerator of the priceto-earnings ratio.

When your son or daughter operated a lemonade stand, you calculated the profits on a cash basis. This is why you came up with an exact figure. They sold $150 worth of lemonade, spent $65 on ingredients, and finished the day with cash profits of $85.

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Wall Street often refers to the true earnings of a company as Net Income. This is the proverbial bottom line, the ultimate profit left after all costs have been removed from revenue.

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The problem is, like anything in finance, it is not an exact figure. If your son or daughter operates a lemonade stand on a hot Sunday afternoon, calculating profit at the end of the day is easy. Your figure will be exact.

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But multi-billion dollar companies are complex beasts, with thousands of employee’s, millions of transactions, hundreds of products, warehouse after warehouse of unsold inventory and years of overlapping inventory purchases, customer sales, servicing of product warranties etc. The ultimate profit a company reports (Net Income) is an accountants “best guess” at the profit the company generated

On the other hand large, complex companies operate under accrual basis accounting. This accounting smooth’s out profits so that revenue and profit is earned when incurred and NOT when the cash changes hands. This may seem like a small point, but it has far reaching consequences.

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I also have a problem with “Net Income” being used as a company’s figure of earnings. This part is going to get a little more complex as we look under the bonnet of GAAP accounting standards. Read along, because I’m going to try and make it simple but remember you don’t need to fully understand any of this.

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But what about the denominator – Earnings?

Consider the case of a small company that rents out cars & vans. In Year 1, they have nothing but $50,000 in seed capital to start their business. They spend it all on 5 cars and 5 vans. They rent out the vehicles and earn $10,000 in revenue throughout Year 1. On a cash basis, they’ve made a loss of $40,000 (Spent $50,000 and made $10,000). But on an accrual basis they’ve made $5,000 (the accountant’s best guess at their net profit). The Reason is Depreciation. Under accrual accounting, instead of assigning the entire $50,000 cash outlay to Year 1 as a lump sum expense - $45,000 is added to the balance sheet as an asset (It is “capitalized” instead of “expensed”).


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The other $5,000 is “expensed” onto the income statement accounting for the wear and tear the vehicles suffered through one year of daily use.

net income with interest & tax expense added back.) Now, some of my sharp business-minded readers may have some questions. How can you simply add back those expenses to net income, usually creating a higher “true income” figure. After all interest and taxes are very real expenses of doing business.

Even with a business this small the net income ($5,000) is an accountant’s best guess at the company’s profit. At a depreciation rate of $5,000 per year the accountant has guessed the vehicles will have a working life of 10 years. After which they will be worth nothing.

The answer is, I don’t recommend using this figure to represent the earnings of a business on its own. I only recommend it for use as the “Earnings” in our adapted price-to-earnings ratio.

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I appreciate I’m probably boring you, but I do have a point.

Here’s the figure we use:

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We need to adapt the earnings side of the ratio from the accountant’s version of earnings to the “cash earnings”, which can be higher or lower but presents a more accurate picture of a company’s true earnings.

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EBITDA – Maintenance Capital Expenditures EBITDA stands for Earnings Before Interest Taxes Depreciation & Amortization. It is calculated as: EBIT + Depreciation + Amortization (EBIT is shown on every income statement on its own line, it is

For calculating a company’s true earnings (other than in use with Enterprise Value) I recommend a measure called Free Cash Flow. Which is simply Net Income + (Depreciation & Amortization) – Maintenance CapEx. The difference being Net Income is after tax and interest expense, whereas EBIT is obviously before.

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If the vehicles were depreciated as if they had a 5 year life, depreciation expense in Year 1 would be $10,000 – Leaving the company with a net income of $0, instead of $5,000.

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The accountant could easily have instead guessed the vehicles will have a 15 year life or even a 5 year life. Each different assumption would change the cost (Depreciation) shown on the income statement.

Here’s why we use the former for the denominator of our ratio: Recall that in the ratio, instead of using Market Capitalization as the price of a business we’re planning on using an adapted version. The adapted version is: Market Cap (price of business) + Debt – Cash. This figure is known among investors as the Enterprise Value or Total Enterprise Value. It is the real cost of buying a business taking account of debt and cash. After all if you buy an entire business you assume the debt and can pocket the cash. Buying one share is no different - you own a fraction of the cash, and assumed a fraction of the debt. Quick Example: If a company has a market cap of $100m you add on the debt ($900m) giving you $1 billion, you then deduct How to Hack the Stock Market

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the cash ($200m) giving you an enterprise value of $800m.

assets being depreciated.

Because you’ve added back the debt, you will have no interest expense. It is as if you bought the entire company for $100m then used $700m of your own resources to pay off the company’s debt.

My adapted version of earnings adds back Depreciation & Amortization expense but then deducts a figure called Maintenance Capital Expenditures. Swapping depreciation expense for maintenance capital expenditures changes the company’s earnings from the accrual basis to the much more accurate cash basis.

We also add tax expense back to earnings because we’re valuing the business as the cash cost of the business to the pre-tax cash flow generated. Companies can have different tax rates, and since the tax rates change almost every year comparisons using pre-tax earnings are on a more equal footing. Besides if a company has lots of debt, a majority of pre-tax earnings will be spent servicing the debt (interest expense) – This would reduce tax expense considerably (unfairly favoring irresponsibly leveraged companies).

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Ok, But Why Add Back Depreciation?

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Good question. As well as adding back interest and tax expense, my version of a company’s earnings also adds back depreciation & amortization. We’ve established Depreciation is the “spreading out” of expenses that could have happened 20 years or more ago. Wall Street loves to tout EBITDA as the figure that should be used for a company’s earnings. The reason is that EBITDA is always much higher than Net Income. But depreciation of assets is a very real expense; my problem with depreciation is that it includes an accountant’s best guess at the life of the

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Maintenance Capital Expenditures are the expenses required by a company to keep Property, Plants & Equipment in operating condition. In terms of a vehicle rental agency, this expense would represent all the maintenance & repairs on the vehicles and eventually vehicle replacements too.

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Technically EBIT is a version of earnings which is “capitalization structure neutral”. Whether a company is funded with lots of debt, or no debt at all – The EBIT is the same because interest expense has been added back.

Coming back to my vehicle rental company, depreciation expense is the $5,000 a year being expensed out of the $50,000 investment in vehicles. The problem is this $5,000 is not actually a cash expense; the cash was spent long ago (in Year 1) and this $5,000 expense is accounting fiction.

This is the real cash cost of wear & tear (repairs & replacements) as oppose to the accountants depreciation figure. Yet again though, there is a problem. Many companies report their maintenance capital expenditures expense somewhere in their filings. The problem is some don’t, and this figure has to be either guesstimated or hardworking investors could call management and ask for the figure. My explanation of the accounting logic above was to cater for my more advanced readers. In most businesses Depreciation & Amortization is a good proxy for Maintenance Capital Expenditures. (It tends to be businesses in decline that are How to Hack the Stock Market

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spending a much lower amount on capital expenditures and instead choose to milk the business for cash flow.) In which case, you simply use Earnings Before Interest & Taxes (EBIT). Therefore the ultimate price-to-earnings ratio to use is: Total Enterprise Value / EBIT Here’s a comparison of the common P/E ratio to our adapted figure. Adapted Price-to-Earnings Ratio

Market Capitalization Net Income

Market Cap + Debt - Cash Earnings Before Interest & Taxes (EBIT)

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Price-to-Earnings Ratio

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I’ll say it again, you shouldn’t use EBIT as a measure of earnings. It is an inflated version of earnings. We’re using it here because our numerator (Enterprise Value) is also inflated due to the added cost of “paying off” the debt.

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Again, I know what you’re thinking. You’re thinking this has all gotten too complex with all this accounting mumbo-jumbo and you’re about to throw this report on the back burner.

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Don’t Worry, You Don’t NEED to Know Any of This!

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You can punch in any stock ticker on Yahoo Finance, (http://finance.yahoo.com) and simply click on “Key Statistics” in the left hand column. This page provides a whole host of ratio’s already pre-calculated for you with one being Enterprise Value / EBITDA (this won’t be too far from our preferred Enterprise Value / EBIT).

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Or alternatively, just grab Enterprise Value (also on this page) and divide by Earnings Before Interest & Taxes (a line item on every companies income statement.)


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We now have the real multiple of earnings the business is trading at. Coca-Cola (KO) trades at: $132.6bn / $9.3bn = 14.3

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You’ll need to pay 14 x earnings to buy Coca-Cola. This is a fair price, buying into companies at a fair price will not make you rich unless the company is about to enter a growth stage. The next chapter will teach you how to use this ratio to find out if a stock is cheap, expensive or fairly priced.


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Chapter 5 – Why You NEVER Pay a Fair Price

This is akin to overpaying for a 2006 Ford Mustang, promising your spouse it is a valid investment and trying to sell it on to an even bigger idiot at an even more ridiculous price. It may work occasionally. But if you do it again and again your batting average will be a loss.

In Chapter 4 I explained how to work out the current price of any stock. This is of course not simply the dollar amount each share trades for since a stock can be cheap at $100 per share or expensive at $2.

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So we’ve established the multiple of earnings as our yardstick. This is the sticker price by which you’ll decide whether to buy shares or not. The next step is to figure out what a fair multiple of earnings would be to acquire the stock in question.

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This multiple, be it a cheap 4x earnings or an expensive 40x earnings, is the “sticker price” of the stock. i.e. All else equal, you can make an investment with a payback period of 4 years or 40 years. This is why the price you pay is so important. You could be exactly right about the next big growth stock but if you overpay you could end up with a capital loss.

You Never Pay a Fair Price

A ‘Fair’ multiple of earnings depends on industry, risk, growth prospects, regulation, profit margins, operating leverage, cyclicality and a whole host of other factors. Because of this figuring out a fair multiple is also a hard task.

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To see the real cost of a stock, you need to relate this dollar amount to what you receive. The last chapter taught you about my adapted price-to-earnings ratio (EV/EBIT). The $100 stock could trade at just a 4x multiple of earnings if EBIT is $25 per share. Likewise the $2 stock could trade at a 40x multiple of earnings if EBIT per share is $0.05.

This is why:

But this is another ‘best guess’ scenario. Being approximately right, most of the time is all you need. Here’s how to do it:

Never Count on a Greater Fool!

Let’s say you’re deciding whether or not to buy a recently spunoff fast food franchise. This chain is called Everything’s Kosher (EKO) and specializes in Kosher chicken fast food.

When you buy a stock at a high sticker price, such as a 30x multiple of earnings. You’re investing using the “Greater Fool Theory of Investing”. i.e. You’re hoping an even bigger fool than yourself will come along and buy your shares from you at an even greater price.

Predictably immense selling pressure after the spin-off has forced EKO from $9 per share to $4. At $4/share EKO is selling at a sticker price of 6x earnings. Considering the company has grown at a clip of 12% per year for the past 4 years and is about to expand you believe you’ve struck gold.

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This brings me to an important point:


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The “Margin of Safety”

The best way to be sure is to check EKO’s price-to-earnings multiple against those of its industry peers. After all the stock market correctly values most companies and so checking a prospective bargain against its peers is a good litmus test.

Bad things happen. Businesses go through rough periods, just like entire economies go through cyclical recessions. There’s no way of knowing exactly what will happen in the future, so the best way you can protect yourself is by only buying businesses at prices that include a margin of safety.

This is where my adapted price-to-earnings multiple comes in. If, like many Wall Streeter’s you attempted to compare companies by their simple P/E ratio, the results would be far from fair. Companies with lots of debt would look much cheaper than they are, while conservative all-equity companies (the good ones) would look expensive.

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This 40% margin of safety achieves two things:

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1. It protects you if things go wrong. Since the company is already valued as if things will go badly (6x earnings) even if things do take a bad turn there isn’t much lower the stock can go.

By using our equation, as taught in Chapter 4:

Big Burger

Dixy Chicken

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Mondo Burger 11

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Let’s say you look at 4 companies from the fast food industry and come up with the following:

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Average Sticker Price = 10x Earnings The stock market is valuing the average fast food business at 10x earnings. Considering Everything’s Kosher sells at just 6x earnings, the stock is trading at roughly a 40% discount to its peers. This 40% discount is called:

2. Secondly, in the long term as an investor you can only ever earn the same return as what your company earns. That is, unless you invest with a margin of safety. In the long term stocks trade at their true value, by buying at a 40% discount to true value your stock will usually rise to true value within the course of 12 months (sometimes 6 months or less).

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You can instantly compare companies on an equal footing. Because you’re removing the effects of different capitalization structures (different levels of debt to equity). This comes in very handy.

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Total Enterprise Value / EBIT

Your overall return on an investment will come from the stock returning to true value (40% gain) and any growth in income that happens during your holding period (10% growth is average). As you can see, most of your return depends on how big a bargain you can get. Investors who buy shares without a Margin of Safety, at a fair or expensive sticker price are counting entirely on future growth for their return. The genius of this investing strategy can be summed up in these two joint realities: 1. The bigger the discount to true value, the lower the risk.


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2. The bigger the discount to true value, the higher the return.

After a few days the restaurateur calls up and says “I’ll cut my price to $150,000 but I need you to sign the contract today!”

Top college’s the world over teach that risk is linked directly to reward. In other words the greater risk an investor is willing to take on, the greater their reward. They apply this mindset to investing in the widely accepted “Efficient Market Hypothesis”. EMT is essentially the idea that at all times stocks trade at their true value.

It’s obvious at $150,000 the restaurant has just became a better investment. It now costs just 7.5x earnings instead of 10x earnings. I mean, come on… Who could possibly refute that? At the lower price you have less downside risk and a higher return on investment.

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On the surface it sounds plausible. But as we’ll see in a moment, to anyone but an academic this logic is obviously flawed.

Imagine this restaurant was publicly traded - When the market cap suddenly dived from $200,000 to $150,000 the Beta value actually increased. i.e. The academics theory of investing would today advise you the restaurant is a riskier proposition at this lower price.

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In other words, EMT says “don’t bother trying to pick stocks because no matter how good your research, you will fare no better than someone who picks stocks at random”.

But…

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EMT further states that at any one point in time a stock price reflects all public information about the company. And prices instantly change to reflect any new public information that is released.

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Here’s why EMT and Beta is so flawed:

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You’ see a corner stone of EMT is ‘Beta’. Academics tell us that the risk of any stock is its Beta. The Beta is simply a value calculated from a stock’s price volatility. If XYZ stock has a beta value of 1, it means it is as volatile as the whole stock market. If ABC stock has a beta value of 1.4, it simply means the stock is 40% more volatile than the market.

Imagine you’re about to buy a local restaurant for $200,000, earning $20,000 a year. You’ve done your sums but you’re still carefully considering the investment. Meanwhile the owner of the restaurant needs the money urgently to pay for a family member’s life-saving heart surgery.

Remember the price of the restaurant dived because of an outside influence – The owner needed to sell quickly for personal reasons. When stocks dive in price, like private businesses often there is a good reason. But occasionally there is not, a stock could equally dive because a large owner is unloading his position. Bottom Line: Academics observed that the stock market was frequently efficient. This I agree with – Most cheap stocks are cheap for a reason. But academics went on to conclude incorrectly that the stock market is always efficient. The difference between the two propositions is night and day. The strategy detailed in this report is to look for stocks that are priced inefficiently by the market, buy them and patiently wait until the market finally revalues the stock efficiently. How Big of a Margin of Safety?


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Your margin of safety (i.e. the discount from a fair price) should be as big as possible. But at the minimum you should demand a 30% margin of safety. I would only use a 30% discount when investing in a good company which I strongly believe will continue growing. In this case, the margin of safety will come from future growth.

For businesses with volatile earnings or high debt loads a 50% or better discount is required.

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For most companies somewhere between a 30% MOS and a 50% MOS is acceptable.


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Chapter 6 – Insider Trading that is Perfectly Legal

I’ve underestimated it. And never a year passes [without me] getting some surprise that pushes my limit a little farther.”

Martha Stewart went to jail for insider trading. But spin-off investors can get great tips from insiders without doing anything illegal. After looking at the earnings record of a potential spinoff investment the place I look next is insider’s compensation. (By the way insiders are company officers, i.e. management)

For the system to work, the sorting must be quick and efficient. The trouble was that, for a time at least, it wasn’t. The company tried all sorts of incentives without much success. Then management came up with the idea of paying their staff by the shift, instead of for the shift. In other words, when the sorting was done the staff could go home. As you can guess, along with the staff at the end of their shift, the problem vanished almost immediately.

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The thing about capitalism is that – it works. If insiders are heavily compensated to make the spin-off company work, it has a much better chance of being a good investment. If insiders of the new spin-off receive restricted stock or options or warrants to buy more – I’m instantly more interested. The more compensation, the better.

Federal Express is one example of a company using incentives to make billions. It has to transport packages within its network to a central location for sorting before sending them on to their final destination.

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Don’t make the mistake of under-estimating this factor. With no incentives management of the new spin-off can happily plod along making modest profits (or even losses) and still collect their huge salaries. But with the prospect of making millions of dollars each by raising the share price – Management suddenly becomes laser focused on making things happen.

All the information about how much incentive (stock, options, warrants etc.) insiders have to make the stock price rise is included in SEC filing Form 10. Don’t worry if that means nothing to you, I have an entire chapter covering these nittygritty details coming up.

Charlie Munger is Vice-Chairman of Berkshire Hathaway, Warren Buffett’s famed investment company. Munger is not well known like Warren, but he is also a billionaire and equally smart. Here’s what he has to say on incentives in investing: “Well I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life


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Chapter 7 – Real Examples of Loophole Profits

Then came along a man called Stephen Bollenbach. Bollenbach had just come away from helping Donald Trump turn around his casino business when he was hired as Chief Financial Officer at Marriott. Bolleanbach had an idea, a great one. Bollenbach’s big idea was to leave all of the unsalable hotel properties, low growth hotel ownership business along with all the companies’ debt in one company – Host Marriott. And spin-off the highly desirable hotel management business, pretty much debt free into a new company to be called Marriott International.

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According to the plan, Bollenbach would become the new CEO of Host Marriott. And Marriott International (the “good” Marriott) would be required to extend a $600-million line of credit to Host Marriott in order to help with any financial problems.

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Instead I’m going to give you two examples of different spin-offs. My first example is of a spin-off homerun (200% gain) while my second is an example of the more normal spin-off opportunity (50% gain). My aim is to bring everything I’ve taught you to life in this chapter.

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The best way of learning the nuts & bolts of this stock market is loophole would be by sitting next to me in my office as I search for and buy stock market bargains. Since I intend to distribute this report widely, unfortunately this is unfeasible.

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Case Study #1: Marriott International spins off Host Marriott

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For years Marriott Corporation expanded their empire by building huge numbers of hotels. However the cream of the Marriott empire was not in owning hotels, rather it was in managing hotels owned by others. Their strategy (which was very successful) was to build hotels, sell them but have it written in the contract that Marriott will continue to manage the hotel at a preset fee. When everything in the real estate market suddenly hit the fan, Marriott was stuck with a load of unsalable hotels and billions in debt which was used to build them.

No extensive research was required to uncover any of this, it was all laid out in a number of different articles in The Wall Street Journal (and many other business newspapers). So in effect, in one fell swoop this attractive hotel management business (Marriott International) was about to shed billions in debt and a load of tough-to-sell real estate. A side effect of creating this business powerhouse is dumping all of the unwanted toxic waste in a new company, Host Marriott. Obviously for us spin-off investors the exciting part was… the toxic waste. With Marriott portraying the spin-off as throwing a load of waste overboard - who was going to want to buy it? No one, no investor be it a Wall Street fund manager or individual is going to want to own Host Marriott. The selling pressure will be even greater than a normal spin-off, creating an even bigger bargain.


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But, how can you be sure it isn’t what everyone thinks, a problem child business saddled with debt and unsalable assets…

investors dream about.

What’s more, nearly 20% of the stock was made available for Bollenbach and the rest of his management team. A pretty big incentive for them to make good things happen for Host Marriott. And finally, the debt situation wasn’t half as bad as people first thought.

The Insiders! I’ve already told you the insiders is the key area to look at when deciding whether or not to invest in a spin-off. The more incentivized the insiders are, the more likely the spin-off will be a homerun (think double or triple) rather than a “mere” 40% or 50% return. When insiders are on your side rather than merely taking a wage things run a lot smoother.

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So how did things work out?

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It could be that way, exactly as things appear on the surface. Or it could be that since no one really cares about Host Marriott, Bollenbach could be entitled to a hell of a lot if he can make the company work. As always, the more incentive this financial whiz has, the better.

Everyone and their mother sold Host Marriott just about as soon as they received their shares. Host Marriott may not be a rockstar company, but it’s worth something – And the immense selling pressure pushed the stock to the levels us spin-off

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Whether you make easy profits investing in boring & undesirable stock market waste, or the same profits gambling on exciting gene splicing stocks that could go big – The money spends the same.

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“Great idea Bollenbach” management would say “I think you’ve just about saved us! Now once you’ve finished throwing that real estate and debt overboard, why don’t you toss yourself over too! Pip, pip. Use that old lifeboat if you want. Cheerio!.”

The Money Spends the Same

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In the case of Host Mariott, Stephen Bollenbach, the architect of the plan, was to become Host’s chief executive. It struck me as strange that the man who had saved a sinking ship (Marriott) would voluntarily jump overboard into the sinking lifeboat, Host Marriott.

What happened to the stock price? Within four months of the spin-off Host Marriott tripled in value. Had you invested $10,000 you had the chance to turn it into almost $30,000. Extraordinary returns from a stock most viewed as “toxic waste”.

Case Study #2: Briggs & Stratton Spins off Strattec Security Briggs & Stratton, a manufacturer of small gas-powered engines (used in lawnmowers, leaf blowers etc.) announced the decision to spin off its highly profitable automotive lock division. At the time, the automotive lock division represented less than 10% of the parents total sales. All of this made it the perfect spin-off opportunity. With the parents market capitalization of over $1 billion it was included in the S&P 500. Since the spin-off would have a market value of under $100 million it was at a size totally inappropriate for almost all institutional holders. What’s more index funds which How to Hack the Stock Market

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held the parent were almost certain to sell their shares.

growth ahead.

It wasn’t until a few months later that the company filed SEC Form 10. This is the document with all the details of the distribution and company to be spun-off. As always I first looked at what incentives would be provided to management to propel Strattec’s stock price.

Most OEM’s in the auto industry trade at roughly 12 x their annual earnings. At this price multiple, Strattec is worth $14.16 per share. But since Strattec has already shown 10% earnings growth in the last 6 months and is on track to add Ford as their second biggest client – I figured it was worth more than the average OEM. At 14x earnings, Strattec would trade at $16.52 per share, this sounded about right.

In Strattec’s Form 10, under the heading “Reasons for the Distribution” the directors revealed the reason for the spinoff. It was just what I liked to see. Strattec was being spunoff precisely so that they could provide compensation to management directly related to the performance of Strattec’s equity. What’s more management was reserving 12 percent of the new company’s shares for management incentives.

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Soon after the usual selling pressure subsided Strattec traded up at $18 per share. A 50%+ gain in less than eight months. Not too bad – and fortunately, far from an unusual spin-off opportunity.

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In addition to looking at insider compensation it is also advisable to read the first few pages of Form 10. The start is like the introduction chapter to a lousy book. But it allows you to pick out the bits of interest and focus your sleuthing in those areas. But mainly you should be looking at management incentives and pro-forma financial statements (more on this stuff later.)

The outcome? For many months after the spin-off Strattec traded at $10 - $12 per share. Not a huge discount from fair value, but the discount here was in addition to expected future growth. With newly focused & incentivized management and the addition of Ford as a new customer it was reasonable to expect good things from Strattec.

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According to Strattec’s pro-forma income statement last year’s earnings came in at $1.18. And for the latest six month period earnings had increased 10% year over year. Unlike Marriott this was not toxic waste. I took a rough stab at calculating a fair value for Strattec’s business. Strattec is an original-equipment manufacturer (OEM) for the automotive industry. In other words, they sell locks for cars. Strattec was already the biggest lock supplier for General Motors and Chrysler. But as an added bonus, deep in the Form 10 they indicated they were about to start supplying Ford too. This gave a strong indication there could be good earnings


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Chapter 8 – Putting it All Together. A Step-By-Step Guide

By searching the SEC database for Form 10 submissions you can find companies about to be spun-off. And within seconds glance at their Form 10 to see if it’s something you’ll be interested in. To get started searching go here: http://www.sec.gov/cgi-bin/srch-edgar

In the search box, enter: ‘form-type = 10-12b OR form-type=1012b/a’ (without the quotes), and choose the desired date range. On the next page is a list of spin-offs, just click on the link [html] and then again click on the very top link, i.e. the document name for item “10-12B”. This will bring up a very long, complex document full of meaningless legalese. We’ll get to this later.

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All you need to do is setup a few alerts, for these terms: Spinoff, Spin-offs, Spinoff, Spinoffs.

1. Navigate to http://www.sec.gov/cgi-bin/srch-edgar and enter “‘form-type = 10-12b”

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There are two services I recommend. Google alerts (http:// www.google.com/alerts), and GigaAlert (http://www.gigaalert. com). Google alert is very basic, while GigaAlert has more features to customize search criteria and delivery schedules. One advantage of GigaAlert over Google’s offering is that it allows you to filter out entertainment websites, since spin-off alerts are often triggered for television spin-offs.

Here’s a step-by-step guide to searching the SEC database for Form 10 and then opening Form 10. (This should be easy but somehow like all government agencies they manage to make their website hard to navigate.)

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Automatic Alerts: Possibly the easiest way of finding out about upcoming spin-offs is to setup an online alert service. These services scan news websites and press releases for any keyword you choose, on finding a news piece containing your keyword the service emails you a link.

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In any one month there is usually just one or two spin-off’s being actually distributed to shareholders. Therefore finding spin-offs is not a hard task. You can use any of these methods:

SEC Web Site: The SEC’s website will be your main resource for digging into the details of every spin-off. But it can also be used to find spin-off opportunities. When a company is about to go through with a spin-off they file a form with the SEC called Form 10. This form gives all the details of the spin-off, pretty much everything you’ll need to know is in the Form 10.


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2. This will bring up a list of all upcoming spin-offs, since every company files a Form 10 when about to spin-off a subsidiary. Under the column “Format” click on [html] for the company you’re interested in.

That’s it! The Form 10 will load in your web browser. After I’ve quickly scanned the document and know I’m interested I usually print it off for further reading.

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Financial Publications: The absolute best financial publication to read is The Wall Street Journal. The WSJ covers virtually every spin-off at some point. And even if you find your spin-off stocks via another method, reading the WSJ’s summary of the situation is a good way to get up to speed without spending hours wading through a Form 10.

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Now you know all about spin-offs and the opportunity they present, the articles covering these corporate events will jump out at you.

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You’ve Found a Spin-off. What Now?

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Once you’ve found a potential spin-off investment you should first look at SEC Form 10 (10-12b). This is the SEC filing companies make when they’re about to spin-off a subsidiary. Form 10 is always a very long document, with lots of boilerplate legal risk warnings etc. that you needn’t read.

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3. This is the final step. On this page you just need to click on the very top red link under the “Document” column. That’s the link for item “10-12B” which is the entire Form 10.

There are some sections that are more important than others. Only after reading the important sections and deciding that a particular spinoff is worth more of your investigation time, should you expand on your reading and do your due diligence. So, what should you look at? • The first section you should read is the ‘Summary.’ In this section, management summarizes what it believes is the most important information about the business and the distribution (the spinoff). After reading the Summary, you should know more about the company’s main business, the industry in which it operates, have a basic understanding of its financial standing, and learn of other significant details


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pertaining to the spinoff.


One advantage of going to the company’s web site is that the information is usually organized in a logical manner. However, be careful relying too heavily on these additional documents. The company may choose to emphasize only part of the bigger picture.

• The next section to look at is the ‘Security Ownership by Management.’ As the name suggests, this section lists what management’s interests are, and also the stakes of other large shareholders (if any). As mentioned before, the more incentives in the form of stock, options and warrants management receive the better.

Investor Relations: Every shareholder is an owner of the company. Therefore you have a right to call the investor relations of department of any company and ask for more information on anything you’re unsure about. Whether you own 1 share or 5% of the company this is your right.

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Occasionally the investor relations department may shun small investors. Here’s what I usually do, ring up the IR department and say something like this:

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If the company is earning money and isn’t coming up against any operating problems (such as increasing costs, losing sales to a competitor etc.) you should try and dig a little deeper. Act like a journalist investigating a story; try to expand your knowledge of the industry and company. Here’s how:

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The Company’s Web Site: The parent company’s web site will often have a section that is dedicated to the spinoff (usually under the ‘investor relations’ link). This is especially true for larger companies. In this section, you will find additional information to the SEC filings. For example, you may find press releases and a slide-show presentation that highlights the key points of the separation.

“Hello, I have a few questions about Company X. I currently own 50,000 shares but am considering doubling my position. My first question is about…”

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Here you should be taking note of: Revenue growth or decline, COGS (Cost of Goods Sold) growth or decline, SG&A (Fixed costs like rent and salaries) and finally you should calculate a fair sticker price based on a multiple of Enterprise Value to EBIT as shown in Chapter 4.

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• Finally you should read the ‘Pro Forma Financial Statements.’ The three important statements are, of course, the balance sheet, the income statement and the cash flow statement. These statements present historical data as if the spin-off company operated independently for some time (hence the ‘Pro Forma’).

Yes, alright you’re telling a small fib. But as a prospective shareholder it’s your right to know the full story. But, before calling the IR department, make sure you’ve done most of your research. Don’t ask questions like “Will next year’s earnings be higher or lower than the last?” rather ask questions like “I noticed the gross margin declined in the last quarter, is that due to the seasonal product mix? How come the same quarter last year had a much higher gross margin?” Your aim is to extract specific bits of information that will help in your analysis not receive financial advice. And remember investor relations employees will usually be inherently bullish on the company’s prospects, ask for specific information and discard opinions. Investing is Sleuthing


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After a few hours of sleuthing you should have a decent level of understanding about the spin-off company, its earnings and expected future. At this stage you should be able to answer questions like:

pro-forma financial results) you can calculate both the sticker price per share and fair price per share. When the spin-off distribution is completed and the new stock starts to trade under its own symbol. You need to calculate the stock’s sticker price. i.e. the multiple of price to true earnings the stock is trading at.

• Is the spin-off actually earning a real profit (Check the proforma EBIT)

Calculating the Sticker Price

• Does the company have an acceptable level of debt (Preferably less than 30% long-term debt to stockholders equity.)

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You cannot make a buying decision on any stock before relating its price to some kind of value. Vulture investors searching for asset rich companies emerging from Chapter 11 may relate the price per share (say, $5) to the Net Tangible Assets per share (say, $12).

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• How are the companies margins compared to its competitors? All other things equal you want to buy high margin companies, i.e. low cost operators. If the gross margin is drastically lower, look for a reason other than “bad business”. Maybe the competitor has lower variable costs (COGS) due to offsetting higher fixed costs (SG&A) i.e. operating leverage.

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Remember valuing a business is not science. It is an art. There are hundreds of questions I could ask and no robotic pattern. Every business is different, and every industry will have different factors you should focus on. In retailing you focus on same store sales, in oil & gas it is reserves and expected future discounted cash flow from these reserves. Don’t worry about reading every word of the SEC filings or understanding every industry-specific measure. As long as you hit the main points (Spin-off details, management incentives,

I personally prefer and advocate investing in good companies without complicating problems. This means I only buy companies with a strong and hopefully growing income stream. Because of this, I relate the price per share to the (adjusted) earnings per share.

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• Does management expect the company to continue growing, sustain current market share or enter a period of terminal decline?

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• Does the company’s EBIT cover the annual interest expense at least twice?

Here’s a reminder of the formula from Chapter 4: Market Cap + Debt - Cash (Enterprise Value) Earnings Before Interest & Taxes (EBIT) Remember, you can use the above formula (which is easy to use) or the slightly more complex version: Market Cap + Debt - Cash (Enterprise Value) EBITDA - Maintenance CapEx The second version is the one I use, because occasionally the accountants Depreciation & Amortization figures (included in EBIT) are far higher or lower than the level of maintenance capital expenditures. One idea is to use the first to pan for viable


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investments (because it’s quick to calculate) and the second, more accurate formula once you’ve found a stock you like.

you are using what management use internally to rate their performance.

The resulting number (Which could be as low as 4 or 5, or as high as 30) is the sticker price of the stock. It is how much you will need to pay to buy the company’s earnings stream.

Forgive me, I digress. After calculating the sticker price (as shown in Chapter 4) you need to find a fair multiple of earnings (Chapter 5) i.e. The average multiple of earnings Wall Street values companies in the industry at. A fair multiple will usually be no higher than 15 unless the industry is fast growing and has exciting prospects ahead.

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To prove to you why FCF is much preferable to Net Income as a measure of earnings, here is a quote from the most recent Kraft Foods 10-K filing:

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“Free cash flow is an internal, supplemental measure of our performance. Our management uses free cash flow as the primary cash flow metric in the budgeting and forecasting processes, as it represents the controllable cash flows from operations. We believe free cash flow shows the financial health of, and how efficiently we are running, the company. We further believe that this non-U.S. GAAP measure provides information useful to both management and investors in gaining an overall understanding of our current financial performance, and that it provides investors with financial information that most closely aligns to our internal measurement processes.”

Kraft is an extremely honest and well-managed company. Because of this they advocate a very raw measure of their financial performance to investors. Free Cash Flow cannot be manipulated or dressed up as GAAP net income can. It is testament to the argument for FCF that when using it,

Note however that industry’s as a whole can be overvalued by Wall Street. If you were investing in dot-com ventures in 1999, an investor wearing blinkers may believe one dot-com company is a bargain because it trades at 60x earnings while the average dot-com trades at 90x earnings.

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My advice from Chapter 4 was to use Free Cash Flow (FCF) as a standalone figure for a company’s true earnings. FCF is simply Net Income + (Depreciation & Amortization) – Maintenance CapEx (i.e. true earnings after interest & taxes.)

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In the above formula’s EBIT and EBITDA – Capex is used to represent the “true” earnings of a company. However, recall from Chapter 4 that these measures are only to be used in conjunction with the Enterprise Value. (Because Enterprise Value includes the cost of repaying net debt, earnings should not be penalized with interest expense which would not exist.)

When investing you need to bring your common sense along for the ride. You wouldn’t make an investment in a private enterprise with a payback period of 60 years. The fact a company is publicly tradable and has a flashing price tag shouldn’t change anything. I advocate comparing the P/E ratios of stocks with their industry peers, but in addition to using common sense. It’s obvious to everyone that a company trading at 5x earnings is a bargain. If something’s that cheap you needn’t bother with a litmus test – Just make sure it’s not that cheap for good reason. All that is left to do is decide on the price per share at which you will buy shares in the spin-off. Take the fair multiple (i.e. 12x earnings) and apply an appropriate margin of safety (i.e. 40% MOS). This leaves you with a buy price of 7 x earnings or better. Now just sit tight and patiently wait. As the new spin-off comes How to Hack the Stock Market

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under immense selling pressure the stock price will decline massively from its initial price. This decline can happen over the course of 1 month or it can take as long as 4 months. My rule is to buy as soon as shares come into my acceptable buying range. Don’t try and time buying so that you buy at the very bottom, you will miss out on a lot of good investments doing that. In this case, at an EV/EBIT ratio of roughly 7 x earnings you should start acquiring a position. Putting it into Practice, a Real Example

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Here’s a real example of me calculating the sticker price of Dell, inc. (DELL). Today DELL is trading at $12.07 per share. This figure is useless to us until we relate it to the earnings stream. You can get your financial data from many different sources: SEC’s Edgar system, Company website, Yahoo Finance etc.

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Once you’re actually interested in a stock you really should go straight to the horse’s mouth (SEC’s Edgar Database). But until that stage, it is much easier to use a financial website like Yahoo Finance. Here’s a quick and easy way of calculating a stocks sticker price.

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1. Punch in the ticker symbol on Yahoo Finance and navigate to the “Key Statistics” page. The page presents a whole load of financial statistics for DELL, but we’re interested in: Enterprise Value and EBITDA.


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investor relations dept and ask for some clarification on this issue. But since we’re looking for a quick sticker price estimate, just err on the side of conservatism. During fiscal 2010, Dell spent $367m on CapEx in total. Conservatively we’ll estimate 80% of this was maintenance capex, i.e. $293.6m (This is probably far too high since Dell themselves imply most of this cash was spent on growth).

Remember the sticker price ratio is:

Enterprise Value EBITDA - Maintenance CapEx We need one more item not provided by Yahoo Finance, that is “Maintenance Capital Expenditures”. Unfortunately DELL doesn’t provide this figure in their 10-K. Instead they state:

By the way, you can find out the total capital expenditures amount from the cash flow statement on Yahoo Finance, it’s under the second section of the cash flow statement (Cash Flow from Investing Activities):

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“During Fiscal 2010 and Fiscal 2009, we spent $367 million and $440 million, respectively, on property, plant, and equipment primarily on our global expansion efforts and infrastructure investments in order to support future growth.”

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• Maintenance Capital Expenditures: Maintenance CapEx for DELL would be spending on repairs and upgrades to machinery that are required to keep output constant. E.g. If Dell had a production capacity of 5 million PC’s a year, if they stopped all maintenance capital expenditures the production capacity would slowly fall as different plants fall into disrepair or become outdated.

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Capital Expenditures come in two forms: Maintenance and Growth.

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• Growth Capital Expenditures: These expenditures are any which will drive future growth. In the case of Dell, any buying of new plants or machinery that will raise production capacity past 5 million PC’s a year. Unfortunately Dell’s management doesn’t give any specifics on the relative amounts of maintenance vs. growth capital expenditures. Though they do infer that most of the 2010 capital expenditures were spent in order to support future growth, i.e. growth capex. Prior to any investment it would be advisable to call DELL’s


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So we have all the information to plug into the sticker price ratio.

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Enterprise Value EBITDA - Maintenance CapEx

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17.65bn 3.7bn - 293m

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So we’ve found out that tech giant DELL is trading at just 5x earnings! This is primarily due to a large cash balance, and very little longterm debt. This makes Enterprise Value far lower than the Market Capitalization, i.e. the real cost of DELL stock is lower than most other investors believe. By sticking to the “true cost” of a company and the “true earnings” you have yet another edge over the average investor.


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This is one of the reasons I like DELL as a potential investment right now. At 5x earnings DELL is priced as if it’s headed for trouble.

lot with mature companies, at a late stage capital expenditures are reduced producing lots of Free Cash Flow – Meanwhile the earnings are still being “punished” for all the huge capital expenses incurred in building the business.

Why is Dell So Cheap?

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Here’s something to note: You’ll notice we used the slightly more complex version of the sticker price formula. This was especially important in valuing Dell.

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Still DELL is a tech giant producing a lot of Free Cash Flow. Their prices are very competitive and they have excellent management (Michael Dell). At a 5x multiple of cash expense to cash earnings, I believe it’s a screaming buy.

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Apple has recently experienced remarkable success with the advent of the iPad. Dell is meanwhile seen as a little old-hat especially since their recent iPad competitor the “Dell Streak” was a huge flop. What’s more they just settled with the SEC for $100m on some accounting charges which won’t have helped things.

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As a late-stage company Dell’s 2010 depreciation charge (a fictional, non-cash expense) was $850m. Meanwhile even a conservative maintenance CapEx (true depreciation expense) was just $293.6m. This disparity means accountants Net Income (the figure Wall Street relies on) is being unfairly punished with high depreciation expense.

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Because of this, in this instance the simpler sticker price ratio is inaccurate: Enterprise Value 17.65bn = EBIT 2.063bn

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The earnings (EBIT) is unfairly punished with a high depreciation charge which in reality does not exist. You may find this a How to Hack the Stock Market

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Chapter 9 – When to Sell

pressure and rises to somewhere near the $14 fair price target. Selling ‘early’ at say $11.50+ and redeploying your capital in another more undervalued spin-off may be a prudent strategy to consider. (Thankfully when investing in spin-offs, this outcome is very common.)

I’ve left this Chapter till last for two reasons: • I have no good answer to the question “When do I sell?”

It is massively important you do not get scared out of your position. If you buy a stock at $7 and it subsequently falls to $4 – it is not automatically a bad investment. However getting scared and selling at $4 will make it a bad investment.

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You then only sell for one of two reasons:

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Due to this flaw in the spin-off system, you’re able to swap every $0.50 you invest for approximately $1 of value. After you’ve invested you’re extremely patient and pretty much forget about the investment, just making a point of reading the quarterly’s (SEC filing 10-Q) as they come out.

Take a look at press releases, 8-K SEC filings etc. and try to establish if value has been destroyed. If it hasn’t, hold your position or consider buying more shares at this even bigger discount.

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Put it this way, ABC Widgets Inc. is a profitable widget maker earning $1.40 per share. Using the strategy laid out before, you roughly value ABC Widgets at $14 per share (10x earnings). If ABC widgets is spun-off and subsequently comes under immense selling pressure it could feasibly fall to $7 per share.

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• If you follow the strategy laid out in this report, and you make sensible and rational buying decisions based on buying bargain stocks. You make a profit before you ever sell your shares. You swap one lower value currency (your cash) for a higher value currency (shares of a bargain stock).

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• A quarterly, annual or other filing (10-Q, 10-K, 8-K respectively) announces some kind of big change for the company or industry. And importantly, you perceive this change to have destroyed more than 50% of the company’s value. (i.e. the event has wiped out your margin of safety, this is very rare). • The spin-off emerges from the period of immense selling

The Beautiful Thing about Spin-offs

The truth is you can buy bargain stocks from all corners of the stock market. 52-week low lists, stocks which are in regulatory trouble etc. And I am a strong advocate of searching high and low for stock market bargains, not just in the corner of spinoffs. But spin-offs have one HUGE advantage over other bargain stocks. If a regular stock is very cheap (e.g. 60% margin of safety) you need to look for a ‘catalyst’ something which will unlock the hidden value and force the stock market to revalue the company. I said before in the long term stocks always trade at their true value, this is true, but by long term I mean 1 – 3 years. All spin-offs come with a strong catalyst just because they’re spin-offs. When the immense selling pressure subsides because


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everyone who wanted to sell, has sold – It is only natural for the stock to quickly bounce up to its true value. And usually the selling pressure subsides in roughly 3 – 4 months.

the upside takes care of itself.” This is because… You Pay a Lot for a Rosy Outlook

This means after 4 months you can sell your spin-off shares at a 50% profit and redeploy the capital in one or even two more opportunities before the year is over. The compounding (reinvesting of your initial capital + new profits) will go a long way to making you rich rather than just someone with a wellmanaged investment portfolio.

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It costs a lot to buy stocks everyone likes. Makes sense right? If everyone thinks the future of a certain stock will be great the price is bid up and up - Often to a level where even the best outcome wouldn’t move the stock any higher. Investors who buy the popular stocks (like followers of Cramer) pay dearly to have the crowd behind them.

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When buying “stock market bargains” you’re often buying boring & unloved companies. You’ll be seen as a stoic and boring investor. But buying shares in an unloved company is like buying shares in Adolf Hitler. There’s not much you can say about Hitler to reduce his reputation further. He’s about the most hated person imaginable.

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Likewise stock market bargains are often so cheap (5-6x earnings) even the revelation of some big unexpected scandal will scarcely lower the stock price. After all, if the stock gets any cheaper (4x earnings?) it’s likely to be a buy-out candidate. On the other hand, the slightest piece of good information indicating a slightly rosier picture of the future will often send a bargain stock rocketing. For a company priced as if doomsday is coming up, even a very slight increase in sales or margins could lead to a 30% rise. The rule is “Watch the downside and

Let me put it this way. Most people who make money in real estate buy “fixer-uppers”. The reason is by fixing up a run down house or apartment complex your profit comes from the value you added by fixing it up. And when buying a run-down place you know you’re getting a bargain and importantly you know why it’s a bargain.

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If you take away only one thing from reading this entire report, let it be this: Don’t buy a stock because you think it will rise in price, buy because in today’s terms you strongly believe you’re receiving $1 of value for every $0.50 you invest.

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In conclusion:

Your profit in this case comes from two areas: The value you added by fixing it up and any general increase in real estate prices in the area. On the other hand, some people invest in real estate in good presentable condition. It’s the nicer, cleaner way of doing things. No real work is involved and everyone will immediately tell you the house is lovely and you made a good investment. But in the latter case, you best be damn sure you picked a good area to invest in. Because your profit is solely derived from the general increase in real estate prices in the area. There is no “safety net” because you cannot add value to the property yourself.


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Likewise if you invest in popular stocks and you inevitably pay a fair price or worse a high price. You better be damn good at predicting the future because you absolutely need things to go great to make a return. Since some expected growth was already priced into the stock you need growth above and beyond the expected growth to fuel your return.

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For me, this is no way to invest. I like shooting fish in a barrel. I don’t want to invest in a company and keep my fingers crossed every time earnings are announced. I don’t want to worry they’ll miss expected EPS by a few cents and the stock will dive. If I wanted the thrill of gambling I’d go to Vegas, I invest to make small but reliable gains not to “luck out” on the next Microsoft.


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Chapter 10 – Further Reading

For the most part cash cannot be manipulated. Had investors in Enron adjusted GAAP earnings to the cash reality – They would have quickly seen Enron was consuming cash, not producing it. Investors believed they were getting wealthier each year since Enron was generating billions in GAAP earnings. In truth had one person owned Enron, running the company would have been an expensive hobby. This GAAP to Cash adjustment didn’t prove the fraud, but it did prove something was amiss.

Financial Statements Demystified: A Self-Teaching Guide

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Once you’ve read even the first few chapters of this book, the strategy I present in this report will become much clearer. You’ll understand why we adjust earnings instead of just accepting net income, and why taking account of debt and excess cash is so important.

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A basic level of financial statement knowledge will make EVERYTHING easier. It will take just a week or so of reading to grasp these basics and here’s the book I recommend:

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Already have a basic level of financial knowledge?

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The next book is much more advanced. And you’ll need to have a strong grasp of financial statements to follow it. But this book is the holy grail. The whole book is dedicated to one topic – “Uncovering Sustainable Cash Flow”. While at first this may seem a small and insignificant point, if you can calculate the sustainable cash flow a company is generating the rest is easy.

Cash is king; this phrase is never truer than when applied to investing. The kid who operates a lemonade stand knows he made a profit because he has more cash at the end of the day. Likewise businesses profit when they have more cash at the end of the year. Often looking at cash flow uncovers the ugly truth that business profits are sporadic. GAAP accounting is designed to smooth over cash earnings giving the appearance of stability.

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In this report I’ve boiled down my investing strategy into a methodical, logical plan that anyone can follow. However, let’s say my report has got you really fired up about investing. Not only do you want to put what I’ve taught you into practice, you want to further understand the logic and reasoning behind my strategy. Perhaps you even want to adjust part of my strategy to fit your worldview.

Investors relying on net income will always have a niggle in the back of their mind. The unsettling thought that perhaps last year’s earnings were a “fluke” and came from some onetime source or manipulation. Many companies have low quality GAAP earnings; we’re not just talking about outright fraud here. If you know exactly how to adjust earnings to the cash reality – You have a huge edge, even over most institutional investors. My obsession with cash flow is not to catch the odd Enron. After all, such frauds are so few and far between you may as well ignore the risk. No, I’m obsessed with cash flow because… Even in a company where no fraud or deception has taken place net income could be $200m while the real, cash earnings could be $300m. This kind of difference will greatly affect your investing decision. Many stocks will have this kind of dramatic difference between the real cash earnings and GAAP net How to Hack the Stock Market

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income.


Here’s the bible of cash flow analysis: Creative Cash Flow Reporting: Uncovering Sustainable Financial Performance

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Here’s one of the best:

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Once you have a good grasp of financial statements you’ll want to start reading about the art of investing. What makes a good company, what will drive future growth etc. These books are often written by famed investors and are a much lighter read than the above mentioned accounting books.

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(Note for Advanced Readers: In this report I’ve used earnings + depreciation as a proxy for cash flow. Even this is not the true cash earnings, because to properly convert GAAP earnings from accrual to cash you need to account for changes in working capital accounts. The above book explains everything and I cannot recommend it enough.)

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One Up On Wall Street : How To Use What You Already Know To Make Money In The Market


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Bonus Chapter #1 – Risk Free Profits via The 2nd Loophole

The actual profit in merger arbitrage (10% here, 5% there) may appear quite small. Because it’s a little like looking for parking meters with some time left on them. The profit is small, but it’s almost risk free if you follow my rules and it’s actually quite fun.

What if I told you there was another stock market loophole I use to fill my pockets with cash. And unlike investing in spinoff’s this loophole is virtually risk free. The name of the game is “Merger Arbitrage” and here’s how to play it:

1. Due diligence by both parties;

Let’s say a merger is announced between two public companies, Company A is acquiring Company B for $11 per share in cash. Immediately after the announcement the stock price of Company B will jump to somewhere near $11, this makes sense, since soon you’ll be forced to sell your shares for this amount.

3. Get preliminary shareholder sentiment (or controlling shareholder approval);

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2. Agree on a price, terms, and contingencies (financing, regulatory approval);

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4. Secure financing arrangements (if needed);

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Here Lies Your Opportunity

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But the thing is, Company B never sells at exactly $11 – Who would want to buy stock for $11, only to sell it later for $11 and incur brokerage commissions on the trade. Occasionally Company B stock will sell for $9.50 or $10 even when the merger is almost a done deal.

In general, the steps of a merger go like this:

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You can buy shares in Company B for $10, wait a few weeks or months for the merger to close and make 10% on your investment with almost 0 risk. The spread between $10 and $11 is the “risk premium”, i.e. the risk that the merger won’t go ahead and you’ll be left with Company B’s stock which may only be worth $8 per share. The trick is to only engage in merger arbitrage when you’re almost 100% sure the merger will go ahead.

5. Obtain regulator (SEC, FCC, any and all) approval; 6. Get final shareholder approval at a meeting called for that purpose; 7. Complete the deal. After step 5 is usually when I buy into a merger arbitrage situation. All you need to do is a little due diligence to make sure steps 6 & 7 aren’t going to spoil the party (stop the merger). The Goal of Arbitrage In arbitrage, the goal is to earn high rates of return on an annualized basis in low-risk, high-certainty situations. I look for “done deals” that are mis-priced due to other peoples’ fear. When would a 5% return satisfy me? When I can get it in a few weeks. If we have gotten past Step 5 and there are two or three months to go, I want to see a 10% spread between the current How to Hack the Stock Market

49


price and the merger or acquisition price.

I don’t know. The types of companies that merge are usually big, sprawling corporations. With subsidiaries operating in multiple industries, there can be all sorts of problems for regulators to pick over. The bottom line is prior to Step 5, there are a number of risks, hurdles and obstacles that still need to be overcome. Investing at this point is more speculation than risk-less.

If the merger or acquisition (or going private) transaction is more than three months out, it likely hasn’t gotten past Step 4 or 5 and is better left for the degenerate gamblers of Wall Street. Just Say No.

Shareholder Approval or “Pretty Much Guaranteed” Approval

Merger Arbitrage is meant to be a virtually “risk-less” way of making money. Let’s dive in with that in mind.

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You know what I don’t want to see? A board that controls just 2% or 5% of the company’s voting stock cutting deals that they can’t close on. When management controls a small fraction of the voting control, they really need the shareholders – or a few large shareholders – to rally behind them to get the transaction done.

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When is a merger virtually “risk-less” profits for the taking? Here’s what to look for:

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I do it all the time and you should do it all the time. Rather than trying to squeeze profits out of everything, wait for that great opportunity and then commit enough of your capital so that it has a meaningful impact.

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I believe that it is human nature for people to want to profit on anything and everything and never lose money in the process. In practice, this is impossible. The number one strength you have is the ability to say “no” and pass on a deal.

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First and foremost, I won’t invest in an arbitrage play prior to Step 5. (See list of steps above.) Keep in mind: Risk-less investing in a merger before Step 5 is like buying any old stock and hoping that things turn out well. Though these companies have teams of smart people preliminarily looking into the regulatory aspects and pitfalls of the transaction, regulatory approval only comes from regulators. Why would regulators kill a deal that the companies thought would go through?

If a few major shareholders acquired stakes as a long-term investment, they may not welcome a merger, acquisition, or going private transaction – particularly if they were acquiring those stakes because they were ultimately planning on bringing in fresh management and masterminding a turnaround or control situation. When management (and in the case of a merger or acquisition, the controlling company) controls 35% or more of the voting stock, there is rarely a question of shareholder approval. With 35% control of the deal, the company needs just 15% outside shareholder approval – hardly a lofty goal. Of course, that assumes that the deal hangs on a majority vote, and not a supermajority (66%, 70% or 80% approval). Financing


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When there are no financing contingencies in an acquisition or going private transaction, I’m happy as pie. (I’m not so happy when a company dilutes existing stockholders’ ownership by issuing new shares to complete a merger or acquisition.)

The RTSX deal is expected to close this quarter. A phone call to the company’s proxy solicitation agent reinforced that (though no additional specifics were given). April 21, 2008 is the final date, after which either party can back out. Shareholder approval (of which management controls more than 40%) is expected at the special meeting of shareholders early next month. (If either party terminates prior to that, there is a $25 million penalty – somewhat hefty considering the size of both companies).

The Risk Vs. The Payoff – Assessing the Odds

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If all the ducks are in order, it is then time to analyze the potential risk versus reward. The risk: If the deal falls apart, the temporarily inflated stock price will likely drop. The Dow has been getting clobbered and yet Radiation Therapy Services (RTSX) has been holding steady around $30. They are set to go private (assuming shareholder approval and final signatures and financing) at $32.50 a share.

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If, however, financing is contingent on a number of factors – especially the market prices of either or both of the companies – you might run into problems. You have to ask yourself: Is this a pretty straightforward deal or do the lenders have a zillion ways to back out.

Why? Liquidity has pretty much dried up and few people are willing to buy or sell for much more (or less) than $30 a share because of the going private transaction. If, however, the deal falls through, you’ll see a lot of workout investors and other shareholders getting out – with the stock price dropping in the process.

The potential payoff is about 8.8% (from $29.87 to $32.50) on an absolute basis. Assuming the deal goes through just before the April 21, 2008 deadline, that comes out to an annualized return of 28.8%, assuming you did this four times a year and reinvested the full proceeds each time. (Tip: You only need a few deals a year so don’t jump into one today just because you are just learning about workouts and think they are a good idea.)

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When there are financing contingencies, you must decide how that will affect the deal, if at all. If financing is contingent on (a) the deal happening the way it was proposed, (b) there being no material changes in the business, and (c) there being no additional debt issuance, (along with other “general” loan terms and conditions) there usually isn’t a cause for concern.

The downside? Assuming you could get out at $27 (a goodtil-cancelled stop order is handy here) your risk is about 10%. Hmmm. 8.8% on the upside, 10% on the down. Doesn’t sound like a good, risk-less transaction, does it? Play the Odds As you look at RTSX, or any other workout situation, you have to analyze the odds as well. You’ll have a hard time finding post-Step 5 deals with 20% upside and 5% downside. It just doesn’t happen. So, what are the odds? What are the odds that this deal will go through? I can’t say for certain, but I do believe that it is better than 50/50. This is nearly a “done deal” and the only things that can upset the applecart seem to be:


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• Virtually unanimous shareholder disapproval;

5. If you determine that the “arbitrage spread” is commensurate with the risks, simply submit a buy order for the stock. Generally, you would hold the stock until the completion of the acquisition, at which point you will receive cash equal to the offer price (and you would be able to avoid transaction fee associated with actual sale of the stock). Alternatively, you can call your broker and instruct them to tender your shares (which most brokers will do for free).

• A substantial change in RTSX’s business; • A major screw-up (and breach of duty) on the part of management or the acquirer. Merger Arbitrage, Step-By-Step: 1. To identify publicly announced acquisitions simply follow business publications (Wall Street Journal, Reuters, or set up alerts on Google). Note that you should not make a trade until the deal is almost done, i.e. Past Step 5 (see above).

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3. Next, identify the difference between the offer price and the current target market price (also referred to as “arbitrage spread”. For example, if the acquirer is offering $10.50 per share and after the announcement target’s price jumps to $10.00, the “arbitrage spread” is $0.50 or 5%.

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4. If you determine that the acquirer will successfully complete the acquisition at the proposed price, gauge whether the payoff is commensurate with the risk. In the above example, if the acquisition would be expected to close within 90 days, simply buying target’s stock and holding till completion will result in a return of 5% in 90 days (or simple annualized return of 20%).

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7. Monitor the news about the proposed acquisitions. While the vast majority of cash tender offers is successfully completed, there is an occasional deal that falls through. If “arbitrage spread” increases dramatically instead of converging on the offer price, the market may be under the impression that the deal may fail, the target will remain independent, and in such an event target’s stock price would likely drop even further. Re-evaluate the risks carefully.

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2. Find out key information about the proposed acquisition: 1. Form of payment (cash, equity, mix), 2. Payoff to target’s shareholders (price offered or exchange ratio), 3. Is the target resisting the acquisition, 4. Is there another company that is likely to make a (higher) offer, 5. Likely horizon for closing the acquisition, 6. Is there likelihood of regulatory intervention?

6. In some instances, it may be prudent to close out your position before the completion of the acquisition. If, for example, you purchase the target’s stock at $10.00, the offer price is $10.50, and after a month from your purchase, the target’s stock price is $10.47, it may be prudent to sell and lock in a monthly return of 4.7% less transaction costs.

All the Work is Done For You: Here’s an excellent website I use to instantly bring up a list of upcoming merger arbitrage opportunities. Make a note of the mergers about to close and simply watch & wait until the stock price floats down to a level at which an attractive profit is on offer: http://www.arbitrageview.com/riskarb.htm


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Bonus Chapter #2 – How to Totally Automate ALL of This!

mum or college student – Copious amounts of reading and analyzing is the last thing they want to do. I don’t blame them. So, what if instead - I told you I can give you a small redbutton? And this red button will sit on your desk besides your computer. But importantly, every time you push this button – It will automate the whole stock picking process. It’ll search diligently for the stocks about to move, it’ll do all the hard work and best of all it’s hardly ever wrong!

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I’m sure you would. Who wouldn’t?

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What’s more to take advantage of this “loophole” you need a mindset about investing that is completely contrary to the mindset of Wall Street. You need to use a long-term viewpoint, you need to be logical and sensible and you need to love the unloved.

Would you be interested?

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Some who’ve read this report will jump up and down at the prospect of “playing” the stock market with this edge. To them (and me) it’s the best sport in the world. Like gambling at Vegas when you can see the dealer’s cards. I’ve gotta’ admit reading 100-pages of a Form 10 holds little excitement for me. I don’t know anyone who likes the “numbercrunching” aspect of it. But this work is like digging for buried treasure. Every page is another spade of dirt. It’s the prospect of finding the buried treasure that keeps me up reading at 3am. But to others, this will all be arduous work. For the stay-at-home

Most people won’t admit it. But effortless profits by just pushing a button is everyone’s dream.

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In the preceding pages I’ve laid out in great detail my strategy for investing. I’ve used this strategy to make many hundreds of thousands of dollars and it’s no harder (or easier) now than when I started. This loophole will never close because the flaw that creates this opportunity is literally built into the system.

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If you’d like to 100% automate everything I’ve taught you so far. And make all the profits, with NONE of the work. Then this may be the most exciting chapter of the report yet.

Well, I don’t have a red-button to send you. But I do have the next best thing. Because here’s how you can…

Imagine this. Imagine you forget about all the technical stuff I’ve taught you in this book. All the SEC filings, the accounting, the search process – Everything. And you go about your normal life. Except every 2 or 3 months I send you an email. This email includes a stock I’ve personally picked. The email includes a detailed summary of the reason I’ve picked it and exactly why I believe it could double or triple in price. How to Hack the Stock Market

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You read the summary, do a little of your own research and place the trade with your stock broker. Within just a month or so I send you another email. It says something like:

Carlos Slim got rich bringing telecoms to Mexico, Lakshmi Mittal got rich building the world’s biggest steel maker, Ingvar Kamprad got rich with the genius idea of flat-pack furniture (IKEA).

“Since I picked XYZ, inc the share price has doubled from $2 to $4 per share. I believe XYZ is worth around $5.50 per share but you should consider taking profit now ready for my next pick.”

The list goes on. Pretty much every billionaire got rich off of one genius idea. Sure there were loads of great decisions along the way, but in most cases the genius idea was destined for success.

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On the other hand, the thing that keeps our risk to a minimum… The buying of little-known stocks trading at dirt cheap prices is also what allows us to make 200%, 300% even 500% returns.

On the other hand, Warren Buffett’s huge wealth was accumulated through thousands of completely independent stock trades. The only common thread being the strategy he devised and followed. A strategy very similar to the one I’ve outlined above.

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Of course, like any investment there are risks. But by buying shares which are huge bargains, where we receive $1 in value for every $0.30 or $0.40 we invest – This risk is kept to an absolute minimum.

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You can invest as little or as much as you like in these picks. Maybe when starting you invest just $2,000 but within a month you sell your shares for $4,000. On the next pick you could invest the entire $4,000 with the prospect of turning it into $8,000 or $10,000.

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Economists wouldn’t agree, their academic theories “prove” the only way to make high-returns is to assume high levels of risk. But for years I’ve exploited exactly the opposite. I’ve made ultrahigh returns buying some of the lowest-risk stocks around.

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Lest you think this is Impossible:

Warren Buffett is the world’s richest man. But what’s interesting about Buffett is that he did not get rich by “lucking out” on one company or product. Nearly every other billionaire you’ll find, even the equally smart Bill Gates (second richest man) got rich because Microsoft was a huge success.

His wealth didn’t suddenly explode when he “hit the big time”. He followed a plan and compounded his wealth at 28% a year starting with just the $5,000 he made as a paperboy. Each year the $5,000 grew & compounded to the point where he is now worth roughly $50 Billion. You cannot replicate the success of Bill Gates. Microsoft was the right product at the right time. A genius move arguably as big as the invention of the rail system or telephone. Even if you personally know a self-made millionaire. In most cases no matter what he or she tells you, you cannot replicate their success. There is no secret. Sure you can copy the work ethic or management style. But I’m talking about carbon copying a blueprint to success, a surefire way of getting rich. To my knowledge there is only one. And this is it. But Don’t Get Excited Just Yet How to Hack the Stock Market

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Look, membership to my exclusive stock picks club doesn’t come cheap. In fact it costs $4,997 per year. And I won’t apologize for charging such a high amount.

profits I make them.

For the past 3 years I’ve sent my stock picks to a small number of subscribers. I send just 4 or 5 stock picks per year and the average gain from each stock pick is 119%!

I’ve recently decided to expand my subscriber base. And the $4,997 fee has given me a problem.

But there is some hope for you.

Sure my current subscribers think this price is a steal, but to those who haven’t yet profited from my picks it’s a big risk. For those who haven’t witnessed the success with their own eyes, spending $4,997 on stock picks is a leap of faith at best.

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I thought long and hard about this problem. Here’s what I came up with:

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I do this work all on my own. Wall Street fund managers boast about having a stable of analysts at their disposal. To me this is a disadvantage. I do all the work myself; because of this I have supreme confidence in my selections. By the time I make a pick, I probably know more about the company & industry than the management!

Most of my current subscribers are people I know in real life or referrals from other happy subscribers.

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You’ see I only send stock picks when I believe they’re a “sure thing”. If you receive a stock pick from me you know I’ve spent at least the past month researching the company. Literally hundreds of hours goes into finding and researching each pick I make.

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Sure I could send stock picks every 2 weeks or month – But I don’t. This annoys some of my members but it’s important I do this.

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Anyway Enough Bragging - You get the Point

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Each stock pick is a very valuable piece of information. It’s the directions to a place you can swap every $1 for $2. And I just cannot sell 4 or 5 of these “nuggets of information” for any less than $4,997. Put it this way, most hedge fund managers charge their clients 20% of profits + a 2% fee on funds under management. To my subscribers this $4,997 is just a 5% or 10% charge against the

Join my small club of stock pick subscribers for just $97. You’ll be a FULL subscriber for 12-months. You’ll receive everything my full $4,997/year subscribers receive. Every 2 or 3 months I’ll email you a stock pick I believe will double or triple in price. Over your 1 year trial you’ll have the opportunity to make tens of thousands of dollars in profit. My hope is that after 12 months of my stock picks. After making tens of thousands in profit from my picks. You’ll have no problem paying $4,997 to become a full member – Especially since you’ll probably be able to cover this from your first-year profits! In summary you’ll receive: 12-Months of My Stock Picks – Just $97 (One-Time Fee)! Fair enough?


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To get started, just click the link below and go straight to the order page:


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How To Hack The Stockmarket

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