Book Summary: Trade Like Warren Buffett

Trade Like Warren Buffett
by James Altucher

Published in 2005
John Wiley & Sons

My Rating: 72%

I haven't done a book summary in a while and it's about time. I haven't read many investment books and haven't really covered some of the must-read classics. Instead, rightly or wrongly, I try to seek out books that I think suits my strategies and thinking. I really haven't read the classic books on Warren Buffett yet but I decided to read James Altucher's Trade Like Warren Buffett. There are many books written about Buffett's 'buy & hold' strategies but very few on his investing related to risk arbitrage, junk bonds, PIPEs, and so forth. This is a unique book that covers the lesser-known strategies used by Warren Buffett.

If you are not interested in Warren Buffett's buy&hold investing then this book is for you; otherwise you may not find much here (other books do a better job on Buffett's buy&hold strategies). This is probably one of the best on Buffett's obscure techniques (again, this is if you are seeking something other than the buy & hold strategy). I don't think this book is worth buying if you are on a tight budget (Sign it out at the library or something.) I'll describe the big flaws that deter from making this a solid book worth buying.

The reason I decided to read this book was because it claimed to cover the "trading" strategies used by Buffett. I personally am not a trader and could care less about trading. However, one of my goals is to deploy around 20% of my portfolio towards risk arbitrage and this fits with the "trading" aspect of Buffett. When I or the book talks about Buffett's "trading," we are really looking at what is called "workouts". Buffett was heavily involved in workouts (Benjamin Graham was mostly into it as well) during his early investment days.

The book covers Buffett's holdings (when the book was published), including his personal portfolio (if the info is available), and talks about various non-buy-and-hold strategies. It finishes off with--what I perceive as the weakest chapters in the book--miscellaneous topics such as investing during disasters, profiting off death, and investing like Bill Gates or Cascades (his investment fund).


Unknown Side of Buffett

The book does a good job in talking about the non-buy-and-hold strategies used by Buffett. Chapters are dedicated to the following strategies, among others:

1. Merger arbitrage
   
2. Relative value arbitrage
   
3. PIPEs and high yield
   
4. Junk bonds
   

Since Buffett rarely talks in detail about any of his investments or strategies, the author injects some of his thinking but I think that is acceptable for most topics (except in the final chapters where his comments have little to do with Bufett's investing).

Merger Arbitrage

Give a man a fish and he eats for a day. Teach him to arbitrage, and he will eat for a lifetime.

-- Warren Buffett

That quote pretty much captures arbitrage and what it's about. The chapter on arbitrage is probably the best chapter in the book. It quotes Buffett's letters and fleshes out some of Buffett's ideas.

This chapter actually changed my investment life after alerting me to Buffett's four key questions to ask for any merger & acquistion deal. I use Buffett's four key questions as a template for all my risk arbitrage now. Buffett's four key questions, which can be found in his 1988 Berkshire Hathaway shareholder letter, are as follows:

1. How likely is it that the promised event will indeed occur?
   
2. How long will your money be tied up?
   
3. What chance is there that something still better will transpire - a competing takeover bid, for example?
   
4. What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?
   

The author also interviews John Orrico of The Arbitrage Fund. It's not the same as interviewing Warren Buffett but but it does tie up the merger arbitrage chapter together. Like the rest of the book, I think the book serves as a starting point for further research. For instance, I went and looked at the referenced Berkshire Hathaway letters to get more information (I actually haven't read many of Buffett's past letters).

Relative Value Arbitrage

This involves buying an asset that is convertible into other assets with higher value. Several good examples are given to illustrate the arbitrage. One of them is Benjamin Graham's relative value arbitrage in 1915 (yes back then) with Guggenheim Exploration Company. Guggenheim holding company decided to dissolve its company and distribute shares it held in other companies. When you added up the value of the shares held by the holding company, it was higher ($76.23) than the stock price of the holding company ($68.88). Graham bought the holding company and shorted the individual companies to yield an almost-risk-free arbitrage profit of $7.35 per share (I say almost risk free because, even though the long/short position eliminates risk in stock price movement, any deal can potentially fail for numerous reasons).

The only example of Buffett that is mentioned in this chapter is what Buffett mentioned in his 1988 Berkshire Hathaway shareholder letter. Buffett took advantage of a situation with Rockwood & Company, which was offering to buy back shares in return for cocoa (this was done to minimize taxes :) . Buffett tendered the shares for cocoa and sold the cocoa for cash to yield a profit.

As small investors, our tactic should be to scour small and medium-sized companies to see if any of them are undertaking corporate restructurings.

PIPEs and Junk Bonds

There is a chapter devoted to PIPEs (private investment in public equity) and another on junk bonds. I'm not going to say much about PIPEs. The problem is that PIPEs are generally only available to wealthy investors or those with some relationship to a company. It is totally inapplicable to small investors like me. Some of Buffett's biggest successes are from PIPEs. Two notable ones are his investment in Gillette (he invested in 10 year covertible with 8.75% coupon) and Salomon (bought convertible preferred with 9% dividend.)

The only insight I gain from Buffett's PIPEs is to look at what yield he uses as a cut-off. I have noticed that Buffett generally invests in fixed-income securities with yields of 8% or more. I have also decided not to invest in any fixed-income without 8%+ yield. This pretty much means that you'll be investing in junk bonds or convertibles in distressed industries. Right now, you can find convertibles and bonds with such yields in industries such as homebuilders, retailers, and financial guarantors.

As for junk bonds, Buffett's 2002 Berkshire shareholder letter contains a lot of notes about junk bonds. To sum up, don't ever buy junk bonds at par; most junk bonds live up to their name; disastrous losses are common.

Given the private-equity-driven LBO boom we had over the last few years, you are likely to see a huge number of junk bonds on the market. Most of thse bonds will likely end up worthless because the companies will have a hard time making the interest payments in a slowing economy.

If one is buying a long-term bond--junk or not--I think inflation may also become a problem in the distant future. So make sure you discount heavily for inflation that will be higher than what we faced in the last 10 years.

Other Topics

The book also contains two interviews with supposedly Buffett-like hedge fund managers: Zeke Ashton and Mohnish Pabri. I think ther interviews are quite interesting. It's always good to hear what other investors, who follow Buffett's teachings, are thinking or doing.


Flaws With the Book

The book is edited poorly, contains spelling mistakes, and seems to go off on tangents. The graphs are terrible, with some almost impossible to see the main item being illustrated.

The last few chapters are a complete waste of time (in my opinion) and have almost nothing to do with Warren Buffett. There is one chapter on Bill Gates and Cascades Investments and it's not clear to me why that was thrown in here (for what it's worth, Cascade runs a concentrated portfolio, and seems to be quite contrarian, with bets on railroads and silver producers back in 2003--this is when they were out of favour.) We also have some trading systems and ideas thrown in by the author but these have nothing to do with Buffett and I don't think Buffett would come anywhere near some of these strategies. I actually think some of the latter chapters are misleading since they are not directly related to Warren Buffett's investing strategies.

Conclusion

Given the flaws cited above, you might think I hated this book. On the contrary. This is a pretty good book because it tries, as best it can, to string together various Buffett strategies that are rarely covered by the mainstream. It doesn't provide any formulas or secret tools that may improve your investment returns, but it may make you investigate investing strategies that you never considered before (such as relative value arbitrage.)

Overall, I recommend this book to anyone that wants to see a "different side" of Buffett. If you are a newbie and interested in risk arbitrage, like I am, then this is a great book. Given that Buffett doesn't generally provide detailed justification for his investments, the author had to piece together various thoughts and inject his own views. Nevertheless, I think it works well and provides ideas that can be used as a starting point for further research. But if you are looking for the conventional Buffett (i.e. buy & hold a strong franchise for the long-term) then this book isn't for you.