I have been following the work of Warren Buffett for many years. He is a man of great character and has really revolutionized investing. Buffett’s fortune can be attributed to several principles, but one in particular is the Law of Compounding. I don’t think anyone really understands this power better than Mr. Buffett.
Why is this important to me?
I start all book summaries with this question because if we can’t answer it, then there’s no point in wasting time watching the video. The simple answer here is knowledge. One of the best ways to learn is by what I call PEO. This represents other people’s experience. Since Mr. Buffett probably won’t take my phone call or guide me personally, it doesn’t mean I can’t learn from him.
This great quote sums up why this topic is important: Give a man a fish and you feed him for a day. Teach a man to umpire and you feed him forever” – Warren Buffett. In the case of Mr. Buffett, teach a man to umpire and make billions of dollars.
One thing that stands out about both Warren Buffett and his partner Charlie Munger is that they are fierce readers. They investigate everything and put things through mental models. Charlie is known as the abominable “NO” man. This means that they pass 95% of the things they investigate and pounce on the other 5%. The knowledge they have gained over the years has honed their skills in these arbitration agreements.
Leverage is powerful when used correctly. Used correctly it should be taken seriously. The financial crash of 2008 shows the power of leverage when idiots don’t really understand it. These arbitration agreements take advantage of OPM, PEO (Other People’s Experience), and OPT for huge profits.
This little book is packed with information. There are 11 chapters on different types of arbitrage that Warren Buffett uses. Due to time constraints, I will focus on three principles outlined in the book.
1. Where does Warren start – This is vitally important because it starts AFTER the public announcement. This right here reduces your potential win by a wide margin, but it also increases your return from being right by 5 times. If he has ever seen the movie Wall Street with Michael Douglas, then he knows that he was using arbitrage along with insider trading to make a lot of money. In the movie, Gordon Gecko seized on the information BEFORE it was public. Obviously he can make a lot of money and go to jail if he is right, but most investors lose a lot of money doing this. Companies will speculate on various “PRE ANNOUNCEMENT” arbitrage opportunities because they know that if they are right one out of 15 times, they can still make a lot of money.
2. Arbitrage Risk Equation – PP/I = PPR. OK – PP (or projected profit) divided by I (investment per share) equals PRR (projected rate of return). There are a couple of additional factors to use here. You need to calculate our LDH, which is the probability of the deal happening. So you would multiply your PP by LDH. So if you had an LDH of 90%, your profit of, say, $5 per share would actually be $4.50 per share. One additional thing you want to see is how long it takes. You might see an offer that only offers a 5% return, but if it’s in two months, it’s like a 30% annual return. This allows you to see the opportunity cost of the investment.
3. Mergers and acquisitions: Since Wall Street is focused on short-term growth, there are countless mergers and acquisitions. Although most don’t work (see the Billion Dollar Lessons book), this means you can make money arbitraging them. Mr. Buffett has made hundreds of millions of dollars in friendly acquisitions including stock-for-stock deals, stock-and-cash-for-stock deals, and cash-for-stock deals. The rest of the book will also discuss all the other types used.
Today we have two main competitive advantages over Mr. Buffet. We can get involved with these offers and NOT change the market price because we are not investing billions of dollars and two, the power of the Internet and search tools can allow us to quickly identify these offers. Warren Buffett admits that his size is an obstacle to investing in these deals.
I hope you have found this brief summary useful. The key to any new idea is to work it into your daily routine until it becomes a habit.
Habits are formed in as little as 21 days. One thing you can remove and make a habit of is Rule #1: don’t waste money. That is why Mr. Buffett only plays it safe when it comes to arbitrage.
