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Book Summary: Warren Buffet and the Art of Stock Arbitrage – By Mary Buffett and David Clark

I have been following the work of Warren Buffett for many years. He is a man of great character and truly has revolutionized investing. Buffett’s fortune can be attributed to several principles but one in particular is the Law of Compounding. I don’t think anybody truly understands this power more than Mr. Buffett.

Why is this important to me?

I start all of the book summaries with this question because if we cannot answer it then there is no sense in wasting your time watching the video. The simple answer here is knowledge. One of the best ways to learn is by what I call OPE. This stands for other peoples expertize. Since Mr. Buffett probably won’t take my phone call and mentor me personally, does not mean that I can’t learn from him.

This great quote summarizes why this topic is important – Give a man a fish and you will feed him for a day. Teach a man to arbitrage and you will feed him forever” – Warren Buffett. In Mr. Buffett’s case, teach a man to arbitrage and make billions of dollars.

One thing that stands out about both Warren Buffett and his partner Charlie Munger is that they are ferocious readers. They research everything and put things through mental models. Charlie is known as the abominable “NO” man. This means that they pass on 95% of the stuff they research and pounce on the other 5%. The knowledge they have gained over the years has honed their skills in these arbitrage deals.

Leverage is powerful when used correctly. Used correctly needs to be taken seriously. The financial meltdown of 2008 shows the power of leverage when idiots don’t truly understand it. These arbitrage deals leverage OPM, OPE (other peoples expertize) and OPT to garner great returns.

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 will focus on three principles outlined in the book.

1. Where Warren Starts – This is vitally important because he starts AFTER the public announcement. This right here reduces his possible gain by a wide margin but also increases his change of being right 5 fold. If you have ever seen the movie Wall Street with Michael Douglas then you know that he was using arbitrage along with inside information to make big money. In the movie, Gordon Gecko leveraged the information BEFORE it was public. Obviously you can make a lot of money and go to jail if you are right but most investors lose big money doing this. Firms will speculate on several arbitrage opportunities “PREANNOUNCEMENT” because they know if they are right one out of 15 times then they can still make big 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 figure our LDH which is the Likelihood of the deal happening. Thus you would multiple your PP times LDH. So if you had a LDH of 90% then your profit of say $5 per share would really be $4.50 per share. One additional thing you want to look at is how long it takes. You may see a deal that only offers a 5% return but if this is in two months then it is like an annual return of 30%. This allows you to look at the opportunity cost of the investment.

3. Mergers and Acquisition – Since Wall Street is focused on short term growth, there are countless mergers and acquisitions. Even though most don’t work out (check out the book Billion Dollar Lessons), this does mean you can make money arbitraging them. Mr. Buffett has made hundreds of millions of dollars on friendly acquisitions including Stock-for-Stock deals, stock-and-cash-for-stock deals and cash-for-stock deals. The rest of the book will look at every other type used as well.

We have two main competitive advantages over Mr. Buffet today. We can get involved with these deals 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 quick identification of these deals. Warren Buffett admits that their size is a hindrance in investing in these deals.

I hope you have found this short summary useful. The key to any new idea is to work it into your daily routine until it becomes habit.

Habits form in as little as 21 days. One thing you can take away and make habit is Rule # 1 – don’t lose money. This is why Mr. Buffett only invests in the sure thing when it comes to arbitrage.


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