I have been following Warren Buffett’s work for many years. He is a man of great character and has truly revolutionized investing. Buffett’s fortune can be attributed to several principles, but one in particular is the Law of Composition. I don’t think anyone really understands this power more than Mr. Buffett.
Why is this important to me?
I start all book summaries with this question because if we can’t answer it, there is no point wasting time watching the video. The simple answer here is knowledge. One of the best ways to learn is through what I call OPE. This means that other people specialize. Since Mr. Buffett will probably not take my phone call or advise me personally, it does not mean that I cannot learn from him.
This great quote sums up why this topic is important: Give a man a fish and you’ll feed him for a day. Teach a man to referee and you will feed him forever. “- Warren Buffett In Mr. Buffett’s case, teach a man to referee and win 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 on mental models. Charlie is known as the abominable “NO” man. This means that they broadcast 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. If used correctly, it should be taken seriously. The 2008 financial crash shows the power of leverage when idiots don’t really get it. These arbitration agreements leverage OPM, OPE (other people’s experts), and OPT to make huge profits.
This little book is packed with information. There are 11 chapters of different types of arbitrage that Warren Buffett uses. For the sake of time, I’ll focus on three principles outlined in the book.
1. Where Warren Starts: This is vitally important because it starts AFTER the public announcement. This right here reduces your possible profit by a wide margin but also increases your change to hit 5 times. If you’ve ever seen the movie Wall Street with Michael Douglas, then you know that he was using arbitrage along with insider information to make a lot of money. In the film, Gordon Gecko took advantage of the information BEFORE it was made public. Obviously you can make a lot of money and go to jail if you are right, but most investors lose a lot of money doing this. Companies will speculate on various “PRIOR 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 must calculate our LDH, which is the probability that the deal will occur. Therefore, you would multiply your PP by LDH. So if you had an LDH of 90%, then your profit of, say, $ 5 per share would really be $ 4.50 per share. One additional thing to consider 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 focuses on short-term growth, there are countless mergers and acquisitions. While most don’t work (see the Billion Dollar Lessons book), this means you can make money arbitrating. Buffett has made hundreds of millions of dollars in friendly acquisitions that include share-for-shares deals, stock-for-stock deals, and cash-for-shares 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 their size is an obstacle to investing in these deals.
I hope this short summary has been helpful to you. The key to any new idea is to incorporate it into your daily routine until it becomes a habit.
Habits are formed in just 21 days. One thing you can remove and make a habit of is Rule No. # 1: don’t lose money. That is why Mr. Buffett only invests in it safe when it comes to arbitrage.
