Understanding Special Situations in Investing: Definition and Example
Key Takeaways
- A special situation is a unique event that influences a stock’s price regardless of its fundamentals.
- These situations can be triggered by events like mergers, spinoffs, or legal actions.
- Investors may capitalize on these events through specialized “event-driven” funds.
- Special situations often involve high risk and potential for significant gain.
- Identifying and acting on these opportunities requires careful analysis and timing.
What Is a Special Situation?
A special situation is an unusual, one-time event that compels investors to buy a stock or other asset in the belief that its price will rise in valuation. The potential opportunity may lie in a well-priced stock outperforming or one that may recover from a fall in price. By definition, a special situation has little to do with an asset’s underlying fundamentals or other factors that investors may watch.
Navigating Special Situation Investment Opportunities
Special situation opportunities can vary widely and involve different asset types. They often come from breaking news or rumors of upcoming news. They may concern spinoffs, tender offers, mergers, acquisitions, bankruptcy, litigation, capital structure dislocations, shareholder activism, stock buybacks, and any other event that might affect a company’s short-term prospects.
A special situation can be positive or negative. For example, a share buyback announcement can temporarily increase a company’s stock price. Conversely, a government inquiry might temporarily lower stock prices, offering an investment opportunity before a favorable outcome.
Important
“Event-driven” or “opportunistic” funds seek out special situations.
Major company stocks often present the most notable special situations. Behind the scenes, savvy investors study debt securities for mispricings or make private placements in struggling companies.
Special situations can appear in any industry and at any stage of the economic cycle.
Strategies for Investing in Special Situations
There are investment funds that are dedicated to exploiting special situations. They usually have “Event Driven” or “Opportunistic” in the names of the funds.
One variation of this investing strategy concentrates on distressed and special situation assets. These investors seek to identify and buy assets that have been underappreciated by the markets for various reasons and are correspondingly cheap.
Special situation investing is a risky business by nature.
A Real-World Example of a Special Situation
A large public company spinning off one of its business units into its own public company would create a special situation.
If the market deems the soon-to-be-spun-off company to have a higher valuation in its present form than it will after the spinoff, an investor might buy shares in the larger company before the spinoff in an attempt to realize a quick price increase.
The Bottom Line
A special situation is an uncommon or one-time event that presents a buying opportunity for investors based on its potential to affect an asset’s valuation. Mergers, acquisitions, spinoffs, bankruptcy, and noteworthy strategic corporate actions can lead to a special situation. Special situation investing is high risk and is associated with either positive or negative market events.
For investors interested in investing in these potential opportunities, there are funds specifically oriented to capitalizing on special situations.