How Warren Buffett Turns Errors Into Profits

How Warren Buffett Turns Errors Into Profits

At this year’s Berkshire Hathaway annual general meeting, Warren Buffett admitted to making two mistakes in 2020

First, selling some of Berkshire’s stake in Apple:

“Apple, it’s got a fantastic manager. Tim Cook was underappreciated for a while. He’s one of the best managers in the world…and he’s got a product that people absolutely love…The brand and the product, it’s an incredible product. It’s a huge bargain to people. I mean, the part it plays in their lives is huge.

I sold some stock last year…that was probably a mistake. In fact, Charlie in his was usual, low key way, let me know that…”

Second, Buffett admitted there was probably too much turnover in Berkshire’s equity portfolio. 

Responding to a shareholder who asked about the level of turnover in the portfolio, Buffett and Charlie Munger had the following exchange (edited for brevity):

Warren Buffett:

I don’t think there’s that much turnover.

Charlie Munger:

There’s way too much.

Warren Buffett:

Yeah.

Charlie Munger: 

It’s still too much. It’s the same amount.

Warren Buffett:

Yeah, I’d agree with that. …And we do relatively little, but as Charlie says we’d do better if I had done less.”

It is easy to look at Buffett’s track record and assume he has never made any mistakes. That couldn’t be further from the truth. Indeed, I could go so far as to say that making this assumption is a catastrophic mistake. 

Buffett has achieved the success he has not because he has not made any mistakes, but because whenever he has made a mistake, he’s learned from it and moved on to the next issue. 

This is a fundamental part of investing. Mistakes are unavoidable in business and in life. Buffett has made many over his life. However, he’s never let one mistake overwhelm him or his portfolio. 

We only need a handful of good investments to earn great returns in the long term. It’s improbable we will find these life-changing investments straight away. 

There will be some bumps and mistakes, but over time the best investments will emerge. Hanging on to these winners is crucial. Cut out the losers, and hang on to the winners. Pull out the weeds and water the flowers. 

Over the past five decades, Berkshire Hathaway has owned thousands of stocks. Still, some of the top holdings in the firm’s portfolio today, such as American Express and Coca-Cola, have featured in the portfolio for decades. 

So why have these companies survived when so many other holdings have been cut? 

It’s because these are the winners. As they have created value for investors year after year, Buffett has held. Other investments that have struggled have been eliminated, and these holdings have floated to the top. 

It really is as simple as that. 

Buffett explained the principle himself at the annual meeting. 

Discussing Berkshire’s decision to write down the value of Precision Castparts, he stated:

“When we’re disappointed in a business, it usually becomes a smaller and smaller percentage of our business just by the nature of things, because it isn’t going any place. When we got a successful business, like a GEICO or something of the sort… GEICO, they’re doing 15 times as much business as when we bought control in 1996… they become a proportionally much more important part of our mix. You really get, through just natural forces, you get more of your money in the things that have developed more favorably than you thought. You actually end up getting a greater concentration in the ones that work out.”

As Buffett described, this process occurs “through natural forces,” there’s little if anything the investor has to achieve this result apart from being patient waiting for great businesses to compound value. 

Buy following this approach, cutting the losers and letting the winners run, Buffett has been able to turn his mistakes into profits.

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