Mike Price sends: In the second part of the books series, I’ll go over my favorite history and intermediate economics books.

To find the first part, which focused on beginner economics and investing books go here.

Intermediate Economics Books

An Austrian Perspective on the History of Economic Thought (2 Vol. Set)
Murray Rothbard was the dean of the Austrian School of Economics in the second half of the twentieth century. He wrote books on economics , early American history , libertarian political philosophy , the federal reserve , fractional reserve banking and the ethics of liberty .

He was the center of the libertarian movement in the 70’s and 80’s (He was a founding member of the Cato Institute, the Mises Institute, the LP and probably any other libertarian think tank or organization you can think of). He essentially created the anarcho-capitalist philosophy and was critical to its expansion in the Austrian School.

This book is Rothbard’s history of Economic Thought. He starts with the Greeks and Lao Tsu and shows how economic history evolved from the Spanish Scholastics, to the first ‘real economist’ (Richard Cantillon), where it fell back a step with Adam Smith, then got better with the French-classical school (including JB Say), was perverted through Marx and finally where the laissez faire tradition started with Frederic Bastiat.

The book is a two volume set comprising over 1,000 pages total. In it Rothbard goes over the economists above and all others. He writes about their economic theories and their lives, showing how they were influenced.

I consider this book the best introduction to the many economists and their theories, unfortunately Rothbard died before he could get into the Marginalist Revolution and the huge onslaught of economics that followed.

PJ O’Rourke On The Wealth of Nations
I find the actual book by Adam Smith virtually unreadable (and for those who can read it, unnecessary as there are so many economists who have said it clearer and better), but this book by P.J. O’Rourke has the essence of the book and allows readers to understand the same theories while laughing and not creating migraines without compare.

The Price of Everything
This was the first book I read on the Hayekian spontaneous order theory. Basically, in a free market prices are the feedback mechanism which create order, sort of spontaneously since there is no one in charge. For example, if there was a hurricane those who needed to build a new house would bid the materials away from someone who had a lesser need for the materials. Without a market there is no way to calculate who is most needing of the materials.

Roberts goes over this in much greater detail in a novel setting. In the story the local grocery store doubles prices after an earth quake, and an economics professor must convince a student activist that this is not the end of the world.

Atlas Shrugged
I read Atlas Shrugged and The Fountainhead in the summer after my senior year of high school. I had planned on only reading The Fountainhead, and it took me basically the whole summer to struggle through it.

Then with a couple days before school started I decided to read a chapter of Atlas Shrugged, and ended up not putting it down for the next two days and finishing the 1,200 page novel with a whole new perspective. Thankfully the arrogance and selfishness subsided, but the main economic theories remained.

In the book Rand follows two different parties - the good businessmen and the government leaders. She shows how government meddling has a bad affect on the economy. In fact one of the characters of the book is so tired of government meddling that he convinces every great business leader or likewise minded person to quit and move into the mountains of Colorado where a kind of paradise is made and everyone trades with gold.

The non-stop sexual references and “selfishness-is-the-only-way,” are annoying, but the book is the best I’ve read at showing all the incentives in an economy and how people are affected by them.

The Failure of the New Economics
I took a macro-economics class last year at college. In the class we basically went over all the Keynesian models, and talked about the Monetarist models for a week and that was it. Thankfully I had this book to use to refute the stupidity I was learning in the class.

Keynes’ General Theory came out in the mid-thirties, just in time for the government to use it to justify more and more government spending. Unfortunately the book is an unreadable blob which seemingly contradicts itself every other sentence.

Thankfully, Henry Hazlitt wrote this chapter-by-chapter (and sometimes line-by-line) refutation of the General Theory. Hazlitt destroys Keynes, and for those who like that kind of thing uses pretty funny writing to do it.

The Austrian Theory of the Trade Cycle and Other Essays
This book contains essays by Ludwig von Mises, Murray Rothbard and F.A. Hayek (probably the three foremost macroeconomist of all time) and has a forward and afterword by Roger Garrison, who is probably the foremost macroeconomist today. Note: none of these labels are accepted by the mainstream economists, who probably haven’t heard of any Austrians except for Hayek.

The essays go over the Austrian Theory of the Business Cycle (wherein a surplus of fake money unnaturally reduces the interest rate and discoordinates investment with consumption, causing malinvetsment and an eventual, but necessary, recession or depression to realign investment with consumption).

Meltdown
Thomas Woods is a historian, and a great one at that, but late last year he took up the task of being the first one to explain the current crisis, and do it from the Austrian point of view.

In this amazing book (the first ever that focused on the ABCT and ended up on the New York Times best seller list), Woods goes over how Greenspan reduced the interest rate to a negative rate and then legislation pushed all the easy money into the housing industry. He also goes over why bailouts won’t work and a recession is the necessary cleaning of malinvestment.

Plus, he backs it up with a history of the priors panics, depressions and recession in the US.

Antitrust: The Case for Repeal
This book is a more focused one.

In it the author, Dominick Armentano, shows how the history of anti-trust is that of lesser competitors trying to find a way to compete without being more efficient or better satisfying their consumers than their better competitors. Armentano also uses monopoly theory to show why Anti-trust is not needed.

Great Austrian Economists
Most of the good advances in Economics have come from Austrian Economists. This book goes over the 15 most prominent, from a Spanish Scholastics in the 1500’s to Murray Rothbard, and shows their additions to economic theory.

The Case Against the Fed
In this booklet Rothbard not only goes over the history of the Fed and shows how it was created frivolously, but also why it is unnecessary and a negative for free societies.

Economic Science and the Austrian Method
In this book Hans Herman Hoppe (the current foremost Austrian) destroys positivism and shows why economics must absolutely be deduced from the action axiom, or praxeology.

History
The Politically Incorrect Guide to the Great Depression and the New Deal

The current crisis is very comparable to the Great Depression, realizing this Bob Murphy (of the PIG to Capitalism) wrote a great guide to it and destroyed all the myths surrounding it.

Unfortunately, his book centers more on destroying myths then the ABCT. But, it is full of great stats and facts and arguments to use to destroy the myths (apparently that’s what it does seeing as I’ve said it three times in two sentences). The book also has a chapter on the current crisis and what the government should do.

America’s Great Depression
Rothbard’s book was the first great one on the Great Depression.

Rothbard goes over the ABCT, kills the arguments against it, then shows how the money supply and easy credit rose in the late 20’s. He also goes over how interventionist Hoover was and how Hoover turned a 2-3 year correction into the Great Depression.

Mobs, Messiahs, and Markets
I just finished this book last night. In it Bill Bonner (of the Daily Reckoning)and Lila Rajiva take readers on a gallop through history to show how mobs are usually wrong and why one should take this into consideration when investing.

Final Thoughts
Most of the books here are more specialized than in the prior list, I believe this allows readers to pick and choose which subjects are most interesting to them at the time and read about that. Again, you do not need to read all of these books right away, though it would do one well to read them all eventually.

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Mike Price sends: This is part two of the series on special situation investing. View part one here. The special situations written about here will be:

Closed-End Fund Arbitrage
Closed-end funds are mutual funds that have a limited amount of shares and trade on a public exchange (NYSE, NASDAQ) like stocks. Because of the nature of the funds trading on an open exchange they frequently trade above, at a premium, or below, at a discount, to their NAV - Net Asset Value or the value of the mutual fund at the time. Thus a smart arbitrager can find a closed-end fund trading at a discount and buy it until the gap closes, or do vice versa and short a closed-end fund trading at a premium.

However it is not that simple - if it was these situations would not exist. Some closed-end funds trade at a steep discount to their NAV, but the discount is probably deserved, as closed-end funds that underperform or have always traded for a discount should not be bought without a foreseeable catalyst - like activists - that will propel the fund back to it’s NAV.

Currently my favorite in this category is the Gabelli Dividend & Income Trust (GDV). The fund “invests at least 80% of its assets in dividend paying or other income producing securities. In addition, under normal market conditions, at least 50% of the Fund’s assets will consist of dividend paying equity securities.” according to its website. Currently it trades for about a 15.5% discount to its NAV. Returns have been satisfactory and the dividend yield is 6.6%, so while you wait for reversion to mean, which is about 18%, you own a fund with satisfactory performance and a good yield.

Activism
A method rising in popularity among hedge fund managers is activism. In this method the manager buys >5% of a company he believes is not returning value to shareholders and becomes active in the business until value is returned to shareholders. When selecting companies to buy the manager usually looks for undervalued companies based low cash flow multiples, or companies with a lot of FCF and cash, he then buys 5 or more percent of the company which requires him to file with the SEC, when he files he not only discloses his holdings in the company but he also writes a letter to the board of directors about why he has bought the shares, what he thinks is wrong with the company and how he believes value can be released. This filing is available for everyone to see on the SEC website. Sometimes the company will immediately comply with the manager, but other times the fight can get pretty scary between a manager and a company.

Obviously regular investors cannot become activists, but ‘piggybacking’ activists is easily possible. When trying to find good activist investments one can use the sec website to follow each filing daily from activists, follow all 13Ds filed, when one is found it must be scrutinized to be reassured that the company will comply with the activist and value will be returned to shareholders, but when an opportunity is found great returns will most likely follow.

Deep, Deep Value
Deep value has been discussed on this site before, I interviewed deep value focused investor Henry Lu and I purchased Lazare Kaplan (LKI) which is trading below its Net Net Current Assets. Deep value is basically buying companies trading deeply below assets, at a very low price to earnings multiple or a very high cash flow yield. Companies trading at a fraction of their book or for 1x earnings is what Benjamin Graham originally championed buying.

This type of investing is usually called “cigar-butt” investing, you buy the stock, or pick up the cigar butt, for one last puff then quickly sell it. When investing in deep value the quality of the company is ignored and the investor is focused just on finding companiess so ignored by Wall Street they can be bought for as low as $.25 on the dollar. Because business quality is ignored value traps may be purchased, value traps are companies which appeared to be undervalued but are discounted for a reason, and they will stay discounted, or fall and become more discounted.

To avoid value traps one must look for companies not only deeply undervalued but also with quality, or at least profitable and have an expectation of earnings which will not fall. Also you must make sure management wants to return value to shareholders, if a company is trading below its cash, you must determine how management is going to use the cash, if they will just let it sit then a discount must be applied to cash to adjust for ignorant management.

LEAPS
I won’t go over the basics of options here, go here for that. LEAPS are options with a longer period of time attached to them, usually about two years.

As an example lets say I have resarched DirecTV (DTV) and have decided they are a good business which is discounted when compared to its peers, has good financials and good management, but the only thing holding them back is the fact that GM holds a large portion of the common stock and investors fear this. I also believe in the near future GM will sell all of these shares, whether it be because they are forced into bankruptcy or if DTV buys back these shares, as they have already started doing.

Because I believe in the company, and think investors will realize this once GM sells the shares and DirecTV is no longer connected to them, I can buy LEAPS for JAN 08 with a strike price of $17, the current price is $17.50 and the options are priced at $2.75. If I buy one contract my investment is $275 (one contract is 100 shares), as opposed to $1,750 if I had bought 100 shares of the common stock.

Lets say in the next year and a half the stock appreciates to $26 per share because GM sells their shares and investors realize it’s a good company, my investment in the LEAPS has appreciated about 330% (I bought them for $2.75 the price of the options is now $9, $26-$17) and my investment in the common stock is up only 49%.

Also if DirecTV were to fall because GM refused to sell it shares or something else happened to force DTV’s shares down you would only lose you initial investment of $275 with the LEAPS, but you could possibly lose a much higher amount.

Conclusion
I believe that even great investors can only find 6-8 really good investment per year, to insure good investment returns when markets are volatile and good investments are hard to find special situations are needed to propel returns to an exceptional level. Afterall special situations are just ‘value with a catalyst’.

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Mike Price sends: I’ve always liked special situations - they remind of a special investigator and how he makes money somewhere where no one else is looking.

I hope to focus a lot focus a lot on special situations this time around, and will be changing my Scottrade account to allow for options trading soon.

So here are the four articles I’ve written before on Special Situations - and as I begin to trade options I will write about the strategies I use.

Arbitrage
Arbitrage is totally risk-free. An example of arbitrage could be buying shares of a company on the NYSE, then selling them immediately on another exchange — like a foreign one — for more money. There is no risk in this — unless your phone breaks and you can’t call your broker — there also so isn’t much reward, because of this I’ll be writing about a different kind of arbitrage, with more potential returns.

Risk arbitrage, is arbitrage, with the risk of losing money attached. Joel Greenblatt wrote the primer on risk arbitrage, he is also the creator of The Value Investor Club Website. I recommend his book for a further look at Risk Arbitrage, or as it is more commonly know Special Situation investing.

There are a number of ways to invest in special situations:

Spin-offs
Spin-offs are my favorite types of investing in special situations. Sometimes a company will decide it will do better, or a section will do better, if part of it is spun-off. Basically a division is separated from the parent company.

A study conducted by Penn State found spin-offs out-perform the S&P by 10% per year, during the first three years of independence.

Peter Lynch talked about spin-offs in his first book.

Institutions have a lot of limitations, detailing the amount of companies they can own, the sizes of companies they can own, the percent of a company they can own, etc. Usually when a division is spun-off the institutions have to sell their shares immediately, resulting in the spin-off being undervalued, if you can understand the new company and find a spin-off undervalued you will likely beat the market over time.

Simply reading The Wall St. Journal will point you towards spin-offs.

Merger Securities
By looking at Investhelp you may find a few companies that are trading below what they will be acquired for. I would strongly advise against investing in any mergers, the risk is to great to make up for small potential returns. If you need to invest in a merger to get your adrenaline pumping before working-out I would say only invest when both companies are 80% owned by insiders who are dead set on the merger going through.

Merger Securities on the other hand are different. Usually companies pay the shareholders of the company being acquired with cash, sometimes shares, when they pay with bonds, preferred stock, warrants, or rights, etc. Companies usually only use merger securities to pay for a portion of the payment - they use them because they probably exhausted their ability to raise cash.

Like spin-offs - and Rodney Dangerfield - merger securities don’t get any respect, institutions sell them almost immediately, producing a great buying opportunity.

This means, don’t try to invest in pending mergers because they’re too risky, but follow the merger and if any merger securities are being used to pay for the company wait a while after the deal goes through - if it goes through - and try to put a value on the securities, they’re probably undervalued.

Bankruptcies
Just reading that makes you think about Airline companies, doesn’t it? You’d think that investing in bankrupt companies would be a way to become one of them, but it turns out it could make you rich, if you do it at the right time…

Don’t buy shares of a company that is currently going through chapter 11, that won’t be profitable until a cow jumps over the moon, and if you have that money to burn you can just subscribe to an expensive newsletter and you won’t need to invest for yourself.

You could buy bonds, bank debt or trade claims from bankrupt companies, but that wouldn’t be smart unless you specialized in bankrupt companies.

There is a profitable way to invest in a company that went bankrupt… After the company comes out of bankruptcy it has to pay off it creditors, usually doesn’t pay them with cash, it pays them with its brand new common stock, and of course do the creditors want this common stock? NO!! Seems like this is happening a lot, institutions own a company and it spin-offs shares or pays them with merger securities and it sells the shares almost immediately, creditors are paid with common stock from a company that went bankrupt and they sell the shares, because they don’t have any reason to hold them.

Investigating this is pretty easy, go to the SEC website, and you’ll find a filing for bankrupt companies that tells you when the bankruptcy issues will probably be resolved, read this and pick your spots only invest in these companies when you are totally sure of the outcome, and have learned more than what you’ve read here.

Going Private Transactions
Cheap Stocks provides a good tutorial here, and the SEC info is here.
Basically micro-cap companies usually have very small revenues, sometimes under $1,000,000, the ~$100,000 they have to pay to the SEC could be 20% of their potential profit, the company will probably want to get rid of these fees.

This is where we come in, if the company can reduce the number of shareholders it has to under 300 it can file at will, and is no longer required to do so quarterly. To do this they have a reverse split, ex. 1-100 for every 100 shares you have they give you one.

If you have less than 100 shares, then the company pays you for the remaining fractional shares. In their SC 13E3 (usually announces the intention to go private, kind of like a proxy statement) they will declare a tender price, which is the price they’ll pay for fractional shares.

When you find a company that is trading well below the tender share price, then, after investigating risk, you would usually buy one less than the split amount to make all your shares fractional.
The bad part is: usually these company’s share prices are so low $100-$1000 is the most you’d be able to invest to make a good profit, sometimes companies will want to go private for reasons other than not wanting to file, they may be big enough that more money could be invested in the situation.
Finding these situations is extremely easy, check this page on the SEC website to find companies that filed the SC 13E3 filing. The Cigar Butt Hunters Group on Yahoo! follows these situations intently. George on Fat Pitch Financials follows all of these transactions, and for $15 a month or $125 a year he tracks the difference between tender and current prices for most arbitrage situations.

Investing here does not go without risk. There is also the problem with the amount of time it takes for the cash to appear in your account.

Restructuring
Corporate Restructurings are similar to spin-offs; in restructuring a business sells a badly performing division of the company — a really big division. Except in restructuring we’re looking to buy the company after the restructuring…

The reason to buy restructuring is hidden value may be obtained from the selling of the bad division, and the company being more profitable. Say a company is trading for $20 per share and it’s earning $1 per share, it has a P/E of 20x and a 5% earnings yield, but one really bad division is losing $1 per share. Joel Greenblatt looks for companies that restructure and sell the bad division, which was depressing earnings. After selling the division the company is making $2 per share, and has a 10% earnings yield (probably above bond yields) the company is now relatively undervalued.

Look for situations that are well managed, have a great business to be restructured around and limited downside. Lastly, make sure the restructuring is significant in comparison to the total value of the company.

Recaps & Stub Stocks
In a Recapitalization a company usually buys a large portion of shares back from shareholders.
An example of this is a company trading at $18 that decides to distribute $15 dollars of bonds to investors, at $18 per share we’ll assume it earns $1.50 per shares, or a P/E of 12x, taking out the 40% tax rate it is making $2.50. After the recap it should be trading at $3 per share ($18 minus the $15 in bonds), it still earns $2.50 per share, assuming the bonds paid ten percent we first subtract $1.50 from earnings for interest expense, which is tax deductible, to get $1 per share, then multiply it by the 40% tax rate to get $.60 EPS.

If the company is trading at $3 this is a P/E of 5x, probably too low. Of course the highly leveraged stub stock (stock after recap) probably doesn’t deserve the same P/E as it did before, but if we assume an 8.33 P/E is justifiable – it’s has the same business model, the only thing that has changed is the amount of debt - it should trade at $5, giving us a recap package of $20 ($5 stock, plus $15 bonds), this is a gain of 11% from the original $18.

Recaps aren’t as popular as they were in the mid ‘80’s, but when you find one Joel Greenblatt says, “There is almost no other area of the stock market where research and careful analysis can be rewarded as quickly and generously.”

Rights Offerings
Profiting from rights offerings is a little bit more complicated then the other situations described here, so I encourage you to buy You Can Be a Stock Market Genius and explore it, to find how to profit from this and other special situations

The third part of the series is about special situations used by hedge funds today, mainly from the books, Super Cash and How to Trade Like Warren Buffett by James Altucher and Value Investing Made Easy by Janet Lowe. I recommend these three books for any one looking to master special situations investments and to be up in down markets as well as rising markets.

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Editor’s Note: Mike Price sends this list of books on economics and investing he has found helpful.

Economics

Economics in One Lesson
This book by (one time New York Times and The Nation writer) Henry Hazlitt, is widely considered the best intro to free-market economics.

It starts with the simple lesson (from Bastiat) that in economics one must evaluate every outcome for every group of people, then applied this lesson to a multitude of topics, all popular when he wrote the book 50+ years ago, and most still valuable today.

An Introduction to Economic Reasoning
This is a text book, it starts with the simple axiom that humans act and logically concludes economics from there.

Gordon fills the book with humor and easy-to-understand examples, plus, since it’s a textbook it comes with many question each chapter to solidify the knowledge learned.

Economics for Real People
Gene Callahan is one of my favorite thinkers today, this is his intro to Austrian Economics book.

Callahan starts by introducing real economics as an a priori science, one that must deal with real individuals, not aggregates. Then, like Mises & Rothbard, shows how economics logically follows from the action axiom.

I have read a lot of economics books before this one and understood likely outcomes of different situations, but this book is the one that tied it all together logically in my head.

The Politically Incorrect Guide to Capitalism
Bob Murphy is my favorite blogger, and his guide is the best for ending arguments (by winning them).

Like all the books in the PIG series (a couple of which are great, but some are crappy) he goes through the main arguments against his position and then destroys them.

It’s great for when you think you found a weakness in the market or can’t find a good way to show someone with whom you’re arguing why they are wrong.

The Politically Incorrect Guide to American History & 33 Questions About American History You’re Not Supposed to Ask

I own about 7 Tom Woods books and have read all but one of them - he is my favorite modern author. These two are great introductions to revisionist US history, showing how, in the US times of prosperity have always come from times of little government and much free market.

The Concise Guide to Economics
This book is more of an index, it contains 37 chapters, all economics topics, with 1-3 pages on each and 3-4 book recommendations for each.

I use it whenever I need a quick refresher on a topic.

Basic Economics
Sowell has written a litany of good economic books, and has a talent for finding examples for what he is trying to say and making it very easy to understand.

Sowell says economics is a science of scarce resources with alternative resources and show economics in that light. The book is very good, but does have some problems.

What Has Government Done to Our Money? Case for the 100 Percent Gold Dollar
In the best book on money ever written, Murray Rothbard shows that money always starts as a commodity, and that the same laws of supply/demand prevent government from doing any good when money is involved.

Investing

The Warren Buffett Way
This book is probably the most read book about Buffett, Hagstrom has written about 7 books about Buffett, Munger and how they invest and use mental models (a couple of which will be in future articles).

In this book, Hagstrom introduces the tenets Buffett uses to evaluate businesses - he looks at the Business, Management, Financials, and Valuation.

The Little Book That Beats the Market
Greenblatt has two books that are in the top ten investing books of all time. This one introduces earnings yield and return on capital, and shows how a screen of these companies returned 30% a year over an 18-year period.

The book serves as a great introduction to value investing and evaluating businesses.

Financial Fine Print & Quality of Earnings

The next two books serve as great introductions to accounting and starting to dig into the footnotes to gain a better understanding of the business and the integrity of those who run it.

Mosaic: Perspectives on Investing
The last book on this list is by, possibly, the best modern thinker in investing - Mohnish Pabrai. I have been to three of his investor’s meeting and can attest that they live up to the expectations.

This book is a collection of articles on investing, Pabrai has a lot of unorthodox views, he talks a lot about finding a company’s DNA, using a latticework of mental models and using a DCF that has a lot of conservatism built in.

The book starts at $130 on Amazon and is approaching Margin of Safety like prominence, but most of the articles have been archived on the internet and you can find them here.

Conclusion
My public speaking professor showed our class a statistic that claimed humans, on average, retain only about 20% of what they read - so don’t get let down if you’ve read 3-4 of these books and still don’t quite ‘get it,’ I am still not as proficient in economics and investing as I’d like after reading these books and many more, but after each book I read more and more of the whole framework ‘clicks’ in my head and I not only understand that part, but the rest of what I understand seems to make more sense.

Also, I welcome any and all suggestions of different books that also serve as great introductions to investing and economics.

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