Warren Buffett wants to give back. His way of doing that (apart from helping billion-dollar charities) is to teach others about his investment principles.
For many investors, it is the sharpness of his ideas and simplicity of his approach that appeal. Those methods seem accessible to all, and Buffett, the CEO of Berkshire Hathaway (BRK/B), is a brilliant teacher.
Of course, Buffett wasn't born with these ideas, nor did they come to him in a flash of light early in his career. He had to keep searching, building and failing, over and over, until he was proficient.
The story of his struggle is encouraging because it emphasizes that success in stock investing doesn't rely on genius, but rather on a continual focus on good principles as well as a willingness to adapt.
Here are four of the ways he has made mistakes — and the lessons they can teach all investors.
He let emotion influence an investment decision
In 1962, Buffett's investment partnership, called BPL, bought shares in a down-at-heel New England textile company called Berkshire Hathaway at an average price of $7.50. It was, he later admitted, a "terrible business."
Berkshire's dominant shareholder and executive was Seabury Stanton. He made a deal with Buffett for Berkshire Hathaway to buy BPL's shares in the company for $11.50. But the formal offer was only for $11.375 a share.
Buffett thought this dishonorable and chose not to sell. Instead, he made what he later called "a monumentally stupid decision": He began to aggressively buy shares. By April 1965, BPL held 39% of Berkshire Hathaway and took control of the shareholder-value-destroying company.
He estimated later that the opportunity cost of keeping the textile business running another 20 years was billions of dollars versus if he had earned returns similar to those on his other investments.
Buffett did eventually find a way to make money from the mills. He gradually moved a lot of the capital of the original business to other areas, in particular to highly profitable businesses like National Indemnity and The Illinois National Bank.
He underestimated customer loyalty
When Buffett was 22, he bought an Omaha gasoline station in partnership with a friend. It was opposite a Texaco station. And the Texaco station consistently outsold his station.
The Texaco station was, in Buffett's words, "very well-established and very well-liked…[it had] customer loyalty…a clientele… Nothing we could do to change that."
The early lesson Buffett learned about the importance of strategic competitive positioning led to some of his best buys, as he sought companies with the most pronounced customer loyalties in their industries, such as Coca-Cola (KO).
He relied too much on quantitative criteria
As we all know, Buffett was strongly influenced early in his career by the ideas of Benjamin Graham. While Graham gave some attention to the earnings power and the qualitative factors of business prospects, quality of managers and stability of enterprise, trumping everything else, in his view, was the strength of the balance and the margin of safety it gave. That's why Berkshire appealed to Buffett: it was a net current asset value buy.
Buffett's investing rules for retirement
Buffett missed out on what would have been some great investments because he was looking for good asset-backing. But he began tentatively moving away from a strong emphasis on quantitative criteria given the success of his investments in Walt Disney (DIS) and American Express (AXP) in the mid-1960s, among others. He sought to put more money into companies with excellent qualitative characteristics, largely regardless of their net asset position.
He learned there was more than one way to be a value investor. But it didn't mean he had to abandon Graham's methods. It is perfectly possible to run a portfolio using the ideas of Graham and the combined ideas of investing great Philip Fisher (author of "Common Stocks and Uncommon Profits"), Charlie Munger and Buffett, as this from Buffett's October 1967 Letter to Partners made clear:
"The evaluation of securities and businesses for investment purposes has always involved a mixture of qualitative and quantitative factors… Interestingly enough, although I consider myself to be primarily in the quantitative school, the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a high-probability insight. This is what causes the cash register to really sing. However, it is an infrequent occurrence, as insights usually are."
But he went on to point out the benefits of also encompassing Graham's quantitatively-biased approach:
"No insight is required on the quantitative side — the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions."
Even today, Buffett and Munger don't reject the idea of quantitative bargains when investing small sums. It's just that when you are investing billions, you can't find these bargains in big enough companies.
He moved too slowly to cut his losses
A relatively recent mistake came with U.K. supermarket chain Tesco (TSCDY) earlier in this decade. Buffett said he sold some of Berkshire's stake in 2013 because of management moves he disagreed with. But he continued to hold a sizable stake. When accounting problems forced Tesco to restate its earnings in 2014, the stock plunged.
By the time Buffett had unloaded all the Tesco shares, Berkshire was faced with a $444 million after-tax loss.
These are just four of the errors Buffett made that helped to hone his approach to hunting out bargains — and can teach us how to be smarter about investing our own money.
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