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Buffett’s 3 Biggest Business & Investment Mistakes
Aspire, Thought Leaders | 11 December 2015
By: Vance Wong
Articles (74) Profile

One might think that being one of the wealthiest people on Earth, Warren Buffett should have made all if not many smart decisions. However, the Berkshire Hathaway CEO, who is also hailed as the Oracle of Omaha, wrote about his three biggest setbacks that he have had in his career in his 2014 letter to shareholders.

Despite being an extremely wealthy person, Buffett is still very humble and he thinks that shareholders and public alike would be able to learn from his mistakes. In the letter, he went all the way back into the past, back when he started off Buffett Partnership Ltd (BPL), his first company.

Berkshire Hathaway’s History

Case study: His first “monumentally stupid decision” was holding onto shares of Berkshire (then owned by Seabury Stanton) when he had the chance to sell for a price 50 percent higher than what he purchased for. Buffett offered $11.50 per share (he bought his initial stake at $7.50) to Stanton when the latter approached the former to buy back those shares. Stanton agreed but when Buffett received Stanton’s letter, it was lowered to $11.375. Buffett was “irritated” and “aggressively” bought more shares, probably in a fit of anger. Buffett Partnership (BPL) owned 39 percent of the company and took over in May 1965, spending “more than 25 percent of BPL’s capital invested in a terrible business.” He finally decided to close the textile operations after 20 years of fruitless stubbornness.

Key takeaway: Evidently, the cause of his mistake was getting agitated at Stanton’s “chiseling” of the deal. “Through Seabury’s and my childish behavior – after all, what was an eighth of a point to either of us?” Seems like the lesson cost Buffett quite a bit but taught us that emotions should not get in the way of an investment opportunity, at the very least one that guarantees a 50 percent profit.

NICO Deal? Not So Much

Case study: Following his first mistake, Buffett went on to commit a second mistake and what he deemed as a “colossal” mistake and the most costly in his career. A long-time friend and the owner of National Indemnity Company (NICO), Jack Ringwalt wanted to sell Buffett an excellent insurance business. However, instead of buying it under BPL, Berkshire became the holding company. This one bad decision caused BPL to lose over $100 billion to legacy shareholders of Berkshire, which otherwise belonged to Buffett and his partners. In some sense, his second and biggest mistake was the result of his first: not selling his Berkshire Hathaway shares to Stanton because of a mere $0.125 less than promised.

Key takeaway: Arguably, the second mistake would not have occurred if the first did not happen in the first place. However, it was on Buffett’s part that he decided to buy it under Berkshire though the legendary investor himself could not explain why. “I’ve had 48 years… and I’ve yet to come up with a good answer. I simply made a colossal mistake.” A key takeaway that we can bring home from this case study is how as investors we should not let undeserving parties into our investing profits. One such way investors tend to let “people in” is through margin trading or “borrowing to invest”. Such methods actually lower the yield of our returns.

Cash: Oxygen for Business

Case study: Buffett made another huge mistake in 1993 when he bought Dexter Shoe, what seemed to be a lucrative deal because of its “terrific record” and “competitive strengths.” However, it seemed that the competitive strengths were soon overwhelmed by even stronger foreign players. Undoubtedly, mistakes are inevitable in the investing world but Buffett’s mistake did not lie in judging the wrong business; he bought Dexter with Berkshire Class-A shares. Buffett used 1.6 percent of his highly-valued Berkshire Class-A shares to buy a “so-so business” for $433 million and that “irreparably destroys value.” The previous owner of Dexter Shoe essentially earned over $5 billion (the price of 1.6 percent Berkshire Class-A shares at the time of the 2014 letter) because of Buffett’s optimism in the shoe-maker.

Key takeaway: Buffett gives a valuable advice: “The intrinsic value of the shares you give in an acquisition must not be greater than the intrinsic value of the business you receive.” As such, it is clear that the safest bet is to use cash to buy shares, especially if you are not sure if you are clearly in the position of strength. In another note by Buffett, he uses the analogy of oxygen to describe how important cash is to any business. The quote directly from his most recent letter:

At a healthy business, cash is sometimes thought of as something to be minimized – as an unproductive asset that acts as a drag on such markers as return on equity. Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent. – Warren Buffett, 2015, in Berkshire Hathaway Letter to Shareholders.

With a Communications background, Vance has the passion to write with a purpose - to provide content supported with substantial evidence to vested readers.

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