Warren Buffett is considered to be the world’s best investor. Over the course of his career, he’s achieved outstanding returns for investors (and himself) buying undervalued stocks. He’s also achieved the best investment hit rate of all time; Buffett has only lost money on a few select occasions and losses have never exceeded more than 1% of capital.
That being said, Buffett has made several mistakes during his career, and the biggest, he believes, cost him around $200 billion.
The Berkshire mistake
Buffett’s biggest self-confessed mistake was the purchase of Berkshire Hathaway. In his 1989 annual letter, Buffett said, under the topic “Mistakes of the First Twenty-Five years”:
“My first mistake, of course, was in buying control of Berkshire. Though I knew its business -textile manufacturing – to be unpromising, I was enticed to buy because the price looked cheap. Stock purchases of that kind had proved reasonably rewarding in my early years, though by the time Berkshire came along in 1965 I was becoming aware that the strategy was not ideal.
If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. …”
He later admitted that this mistake ultimately cost around $200 billion in lost profits.
But why did Buffett, who’s known for his rigorous and focused approach to business analysis make this mistake?
The simple answer is revenge. Buffett allowed his emotions to get in the way. He initially acquired Berkshire stock as a deep value play when he was running his partnerships in the early 1960s. The thesis was simple, the stock was trading below book value, and the firm (which back then was a major textile business) was losing money.
However, management was restructuring the business, selling of textile mills and using cash from the sales to repurchase shares. Buffett saw this unique situation as an easy way to make a risk free profit as Berkshire unlocked value from its balance sheet and returned cash to investors. As Buffett described in an interview with CNBC in 2010:
“And here was this cheap stock, cheap by working capital standards or so. But it was a stock in a— in a textile company that had been going downhill for years. So it was a huge company originally, and they kept closing one mill after another. And every time they would close a mill, they would— take the proceeds and they would buy in their stock. And I figured they were gonna close, they only had a few mills left, but that they would close another one. I’d buy the stock. I’d tender it to them and make a small profit.”
As Buffett became a substantial shareholder, management took interest and consulted with him on future tender offer decisions:
“So I started buying the stock. And in 1964, we had quite a bit of stock. And I went back and visited the management, Mr. (Seabury) Stanton. And he looked at me and he said, ‘Mr. Buffett. We’ve just sold some mills. We got some excess money. We’re gonna have a tender offer. And at what price will you tender your stock?’
And I said, ‘11.50.’ And he said, ‘Do you promise me that you’ll tender it 11.50?’ And I said, ‘Mr. Stanton, you have my word that if you do it here in the near future, that I will sell my stock to— at 11.50.’”
Mr. Stanton ignored this promise:
“I went back to Omaha. And a few weeks later, I opened the mail…11 and three-eighths. He chiseled me for an eighth. And if that letter had come through with 11 and a half, I would have tendered my stock. But this made me mad. So I went out and started buying the stock, and I bought control of the company, and fired Mr. Stanton.”
So, Buffett ended up owning Berkshire Hathaway, a struggling textile business that was consuming vast amounts of capital but producing very slim returns. As Buffett said in a 1985 letter to shareholders:
“Thus, we faced a miserable choice: huge capital investment would have helped to keep our textile business alive, but would have left us with terrible returns on ever-growing amounts of capital. After the investment, moreover, the foreign competition would still have retained a major, continuing advantage in labor costs. A refusal to invest, however, would make us increasingly non-competitive, even measured against domestic textile manufacturers. I always thought myself in the position described by Woody Allen in one of his movies: ‘More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness, the other to total extinction. Let us pray we have the wisdom to choose correctly.'”
Berkshire wasn’t the only company operating in the space, another firm, Burlington was competing with Buffett’s operation at the time, and its struggles give us some fantastic insight into just how unproductive the textile business was at the time. Buffett wrote the following in his 1985 letter:
“Burlington made a decision to stick to the textile business, and in 1985 had sales of about $2.8 billion. During the 1964-85 period, the company made capital expenditures of about $3 billion, far more than any other U.S. textile company and more than $200-per-share on that $60 stock. A very large part of the expenditures, I am sure, was devoted to cost improvement and expansion. Given Burlington’s basic commitment to stay in textiles, I would also surmise that the company’s capital decisions were quite rational.
Nevertheless, Burlington has lost sales volume in real dollars and has far lower returns on sales and equity now than 20 years ago. Split 2-for-1 in 1965, the stock now sells at 34 — on an adjusted basis, just a little over its $60 price in 1964. Meanwhile, the CPI has more than tripled. Therefore, each share commands about one-third the purchasing power it did at the end of 1964. Regular dividends have been paid but they, too, have shrunk significantly in purchasing power.”
If Warren Buffett had continued to pursue Berkshire Hathaway’s business of producing textiles, then it’s improbable the company would be what it is today. This is his $200 billion mistake. Even though it cost him billions in lost profit, ultimately, Buffett learned a valuable lesson on the financial cost of becoming emotional about investments.