What Is a Special Situation in Investing With Example

What Is a Special Situation?

A special situation is an unusual event that compels investors to buy a stock or other asset in the belief that its price will rise.

The special situation by definition has little to do with the underlying fundamentals of the stock or any other rationale that investors ordinarily use to select investments. It is an attempt to profit from a potential rise in valuation that the special situation presents.

Alternately, it can be an attempt to profit from the anticipated recovery of a stock whose price has been depressed by a special situation. It's the classic "buy low, sell high" advice. The special situations investor has sensed an opportunity.

Understanding the Special Situation

Special situation investment opportunities can take many forms and involve a number of asset classes. They often arise from breaking news stories or rumors of news about to break. 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 may be either positive or negative. That is, a positive event such as the announcement of a share buyback may cause the stock of a company to trend upwards in the short term. Or, a negative event such as a government antitrust inquiry may depress the price of a company's stock temporarily, thus offering an opportunity to the investor who foresees the inquiry ending in the company's favor.

The stocks of major companies provide the most visible special situations. However, behind the scenes, sophisticated investors analyze senior and subordinated debt securities to look for mispricings to take advantage of, or engage in private placements in a distressed company.

A special situation can surface in any industry during any point in an economic cycle.

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.

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.