Learn to invest with Buffett

Chapter 63

Chapter 10 Section 4 Relative value arbitrage: Can obtain greater value

When we have more money than ideas, we sometimes get into arbitrage territory.

--Warren Buffett
Buffett and his predecessors once specialized in another kind of arbitrage - "relative value" (relative value) arbitrage, which is the most basic part of Buffett's "debt restructuring" strategy.Relative value arbitrage is to buy an asset in advance and convert it into another asset at that time, so that a greater value can be obtained.

Simply citing one of the most prominent examples is the case of Palm Computing and 3Com.Palm was spun off from 3Com when 3Com decided to publicly sell its Palm stock.On the first day of trading, Palm's stock price soared that 3Com's share of Palm's equity was worth more than 3Com's own highest market value.This market effectively measures the value of 3Com's current and growing operations less than the highly profitable zero-business situation that has existed for 30 years, an example that will be discussed in more detail later.

Another example occurred in 1915 when Graham worked for New burger, Loeb & Company, and he stumbled upon the following relative value arbitrage company: Guggenheim (Guggenheim) Development Company, now the Guggenheim family, famous in Manhattan's art museums, relied on buying and the development of minerals and fortune.Guggenheim Development Company holds shares in many mining companies.On September 1915, 9, the company decided to distribute stock held in other companies to its shareholders.It was trading at $1 per share that day, so Graham figured that buying one share of Guggenheim Developments would yield a net arbitrage profit of $68.88, which he shorted while buying shares of Guggenheim Developments stocks, thus locking in profits.

In the 20s, when DuPont was capitalized on the cash it earned during the war, it bought most of the stock in General Motors.Even though the market was discounting DuPont's other businesses and 20Com's business at the time, Graham capitalized on the spread by buying DuPont stock and shorting General Motors stock.Although Graham still valued DuPont's stock, he only valued the part of General Motors, and treated the other aspects of the company's stock as zero value.

Investment motto:

When investors use this method for arbitrage, they should know that there are two risks in this strategy. The first risk is the basic risk, which occurs when the stock values ​​of two securities cannot converge. For example, in the event that the parent company may go bankrupt, the value of the stock in the asset split is ultimately used as collateral before the bankruptcy.For arbitrageurs, another risk is financial risk, even if the value of the two securities tends to be the same, which may lead to potential losses for the initial arbitrage behavior.

(End of this chapter)