How to Beat the Stock Market Casino

For a lot of people, the stock market looks like one big casino.

And, to some extent, the casino analogy works. There are parts of the market that are consistent losers for investors…

The initial public offering market is one of those. It�s true that some IPOs are big winners. Anyone who bought Microsoft or Home Depot or Wal-Mart at the IPO and held on got rich. These are people somewhat like those who hit the jackpot playing slots. It�s not a typical experience. Most of the time, if you buy IPOs, you�ll lag the market. In truth, an IPO is when insiders sell something they no longer want at prices they�d never pay.

There are lots of other ways to lose money in the markets. In my book Invest Like A Dealmaker, I cited research by J. Carlo Cannell that showed how restaurants, semiconductor capital equipment companies and computer manufacturers were industries that actually generated negative returns for investors for more than 20 years running.

But the casino analogy falls down in lots of other ways. If you know what to look for, you don�t have to play the loser games. You can choose to play only games in which the odds tilt in your favor. Then, over the long haul, with patience and diligence, you will make a lot of money.

What you want to look for is one of those pools from which investors consistently take money out of the market. These include things like spinoffs,thrift conversions and other quirky sets of ideas that collectively beat the market over time�

For many of these, there are structural reasons for the outperformance. In other words, how the market creates these securities practically bakes in the outperformance.

Today I want to share with you another idea along these lines: a post-bankruptcy stock.

Joel Greenblatt � who wrote the bible on �Special Situations� investing and enjoyed 10 years of earning 50% annual returns doing it � writes:

�The new stock of a formerly bankrupt company may be relatively undervalued because Wall Street analysts don�t yet cover it, because institutions don�t know about it or simply because the company still retains a certain stigma from the bankruptcy filing.�

Bankruptcy is a wonderful thing. It allows a company to hit the reset button and start over. Sometimes good companies go bankrupt simply because they got caught during a bad time with too much debt. Bankruptcy rights that situation and sends the company back out into the world with a better balance sheet.

So you can still find good companies � with good market niches, cash flow and margins � coming out of bankruptcy.