A few weeks ago I wrote an article for GuruFocus outlining one of Warren Buffett’s biggest mistakes of all time; selling Disney.
Buffett first noticed Disney back in 1966. The company at the time was selling for $80 million in the market with a debt-free balance sheet, significantly below what Buffett’s estimate of intrinsic value for the business.
Smelling a bargain, Buffett invested $4 million of his partners’ money to buy a 5% stake. A year later, he sold this position for $6 million netting a profit of $2 million or 50% in just 12 months.
However, today that 5% position would be worth around $8 billion. In other words, Buffett’s decision to book profits early cost his investors $7.998 billion.
We can learn two things from this investing case study. Firstly, it’s always best to let your winners run and secondly, it pays to invest in what you know.
Buffett bought Disney because he understood the business, how it made its money, and why the stock was undervalued. He described his process in one of three lectures to students at Notre Dame in the Spring of 1991:
“So, when we find something we understand, if we’re buying all of the business, I want to like the people. If we’re buying part of the business, it’s less important. We want to buy things we understand, and we want to buy them very cheap. If we don’t understand them, we don’t buy them. If they’re not cheap, we don’t buy them
We bought 5% of the Walt Disney Company in 1966. It cost us $4 million. $80 million bucks was the valuation of the whole thing…The Pirate’s ride had just been put in. It cost $17 million bucks. The whole company was selling for $80 million. Mary Poppins had just come out. Mary Poppins made about $30 million that year, and seven years later you’re going to show it to kids the same age. It’s like having an oil well where all the oil seeps back in.
Now the [numbers today are] probably different, but in 1966 they had 220 pictures of one sort or another. They wrote them all down to zero – there were no residual values placed on the value of any Disney picture up through the ’60s. So [you got all of this] for $80 million bucks, and you got Walt Disney to work for you. It was incredible.
You didn’t have to be a genius to know that the Walt Disney company was worth more than $80 million. $17 million for the Pirate’s Ride. It’s unbelievable. But there it was. And the reason was, in 1966 people said, “Well, Mary Poppins is terrific this year, but they’re not going to have another Mary Poppins next year, so the earnings will be down.” I don’t care if the earnings are down like that. You know you’ve still got Mary Poppins to throw out in seven more years, assuming kids squawk a little. I mean there’s no better system than to have something where, essentially, you get a new crop every seven years and you get to charge more each time. $80 million.
I went out to see Walt Disney (he’d never heard of me; I was 35 years old). We sat down and he told me the whole plan for the company – he couldn’t have been a nicer guy. It was a joke. If he’d privately gone to some huge venture capitalist, or some major American corporation, if he’d been a private company, and said “I want you to buy into this. This is a deal,” they would have bought in based on a valuation of $300 or $400 million dollars. The very fact that it was just sitting there in the market every day convinced [people that $80 million was an appropriate valuation].
Essentially, they ignored it because it was so familiar. But that happens periodically on Wall Street. I wanted to go see Mary Poppins, to see if she’d be recycled, and she was showing at the Loews Theater on 45th and Broadway in New York, and here I am with a briefcase at 2:00 in the afternoon heading in to see Mary Poppins. I almost felt like I had to rent a kid.”
Buffett has built the fortune he has today by being greedy when others are fearful, but more importantly, he’s been willing to go the extra mile and do the research. Contrarian and value investing only makes sense if you know what you are buying, and the only way to do that is to put in the hard work and do your research.
Unfortunately, there’s just no short cut.
The author owns shares in Berkshire Hathaway.