Warren Buffett, 39, Arbitrageur
"I make no attempt to forecast the general market - my efforts are devoted to finding undervalued securities. -Warren Buffett, February 11, 1959
Every few years I re-read some of Warren Buffett's early letters to his partners, written before he became the lovable grandfather who drinks Coke and before there was a Berkshire Hathaway (BRK.A / BRK.B) as we know it.
Today, Buffett's investing strategy is largely influenced by structural opportunities (people bring him deals because of who he is) and structural impediments (so much capital to invest and a lack of anonymity). This makes his current decisions and style less relevant to other investors. However, digging deeper into Buffett's past, there are lessons that can teach us exactly how he got to where he is today.
In 1969, Warren Buffett may have been tap dancing to work, but he also would have tap danced right over anything that got in his way. He was the furthest thing from folksy; he was an arbitrage specialist.
While he puts on the appearance of someone mildly befuddled by complexity, Buffett was as sophisticated as it gets at exploiting "workouts" as he called them. Workouts referred to securities with a specific timetable that arose from corporate activity - liquidations, acquisitions, reorganizations, spin-offs, etc. These were publicly announced activities that could be read about in the newspaper. Buffett's edge wasn't that he had better information than everyone else. It was that he understood that in these "workouts" held the potential for significant mispricing by the market, where the market price of the security no longer accurately reflected the true value of the underlying asset.
In Warren Buffett's 1959 investor letter, he cited the Commonwealth Trust Co., a bank which was trading at about $50 while its intrinsic value was conservatively estimated at around $125. The discount arose because the company paid no cash dividend at all. The value to Buffett came from the mispricing and the opportunity came from the market's arbitrary focus on cash dividends. Buffett also recognized this stock as a potential takeover candidate. He was not an outside passive minority investor in this situation. In fact, Buffett specifically emphasized that his scale was sufficient to make him a player in the discussions about any merger proposal. Buffett was an activist investor, comfortable with stock exposure as large as a 25% concentration, and willing to create his own catalyst to unlock value.
I would prefer to increase the percentage of assets in work-outs, but these are very difficult to find on the right terms. To the extent possible, therefore, I am attempting to create my own work-outs by acquiring large positions in several undervalued securities. -- Warren Buffett, February 11, 1959
Buffett is a winning card player and he plays with an edge. His investment style has evolved over time as his edge has changed, but he always maximizes his edge. Make no mistake, what Warren Buffett does is neither simple nor easy.
For anyone who wishes to invest like Warren Buffett, my suggestion would be to invest alongside Buffett in order to take advantage of his unique edge. Berkshire Hathaway has publicly announced their intention to buy back shares whenever the stock dips below 120% of book value. By buying shares or writing puts near that price, an average investor can piggy-back off one of the greatest investors in history, and buy shares at the same price.