Buffett's Biggest Investment Mistake

What is Warren Buffett's biggest investing mistake to date? We no longer need to guess at the answer. In an interview that aired yesterday on CNBC, the CEO of Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) said "the dumbest stock" he ever bought was ... Berkshire Hathaway. On the scale of mistakes, this was a beaut – Buffett estimates the opportunity cost of the investment at roughly $200 billion.

A $200 billion blunder for want of an eighth of a dollar
Here's the background: In 1964, Buffett was ready to tender shares he had accumulated in a small textile company -- Berkshire Hathaway -- back to the company. He met with the CEO and they agreed a price of $11.50 a share. Back in Omaha, Buffett received the official tender offer... at a price of $11 3/8! In Buffett's words, "He chiseled me for an eighth." Furious, Buffett refused to tender his shares. In a ruthless and vindictive response, Buffett instead accumulated more shares, eventually taking control of the company -- and firing the CEO.

How did this turn into a $200 billion missed opportunity? At the time of the acquisition, the money Buffett invested in Berkshire's capital represented a substantial part of his investing capital. That investment turned into an "anchor" on returns for twenty years (the original Berkshire Hathaway was eventually shuttered); meanwhile, Buffett's other investments flourished, generating enormous profits.

Buffett could have doubled up!
Buffett believes that if he had allocated the capital he sank into the textile business to his insurance business instead, the resulting conglomerate would be worth twice Berkshire Hathaway's current market value ($205.6 billion). Given the extraordinary success that Buffett achieved despite this misstep, his estimate is eminently plausible.

Among other lessons, this episode taught Buffett to focus on high-quality businesses, rather than businesses that look cheap. (This had been the approach of his mentor, Ben Graham.) This is particularly important when you choose to live with your mistakes; indeed, Buffett prefers to "keep the businesses that aren't as good as the others".

That makes perfect sense when it comes to control investments (i.e., the purchase of entire businesses); that sense of permanence is part of what makes Berkshire a preferred buyer of private companies. In many such situations, Berkshire is the sole bidder.

Buffett's approach doesn't make sense
I have a harder time understanding the rationale for that attitude when it's applied to non-control investments in publicly traded securities. In the public markets, Buffett's refusal to sell yields him no advantage the next time he wants to buy a different stock. Furthermore, he appears to apply this rule inconsistently. Take two examples of businesses that have declined in quality: Why sell down your position in Moody's (NYSE: MCO  ) , but not in the Washington Post (NYSE: WPO  ) ? If you have an explanation for this behavior, please add it to the Comments section below -- I'm genuinely curious.

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Fool contributor Alex Dumortier, CFA has no beneficial interest in any of the stocks in this article. Berkshire Hathaway and Moody's are Motley Fool Inside Value selections. Berkshire Hathaway and Moody's are Motley Fool Stock Advisor picks. Motley Fool Options has recommended writing covered calls on Moody's. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 19, 2010, at 4:19 PM, diegorgazzi wrote:

    That's Easy, Buffet is selling MCO because of the reputation. Buffett and everyone knows MCO was completely untouched by the US regulation and the business model is exactly the same. It's a matter of time before the PE ratio returns to the low 20s, but to Buffett it's not worth his reputation to be associated with MCO... after all, MCO is only worth a few $ Billions which is nothing for Berkshire's Portfolio. Clearly, owning or selling MCO would have little effect on Berkshire's pockets... the fact that he's even bothering to waste his time selling (especially when he testified that it's an excellent business) clearly shows that it's a reputation problem.

  • Report this Comment On October 19, 2010, at 4:50 PM, TMFAleph1 wrote:

    @diegorgazzi

    Thanks for your comment: Yours is a very believable explanation.

    Any thoughts on why Buffett takes the same 'no-sale' approach to investments in public equities that he takes in the private market?

    Alex Dumortier

  • Report this Comment On October 19, 2010, at 6:06 PM, DavesHere wrote:

    I have to wonder whether a reminder of fallibility isn't worth something. And it is unlikely he would have doubled. More likely, he would have bought something promising, balancing or both, like...Pier One. As to Washington Post, twenty years ago, control of the news was centralized, and Washington Post had the inside track at the heart of news generation, D.C. Today, control of news flow is decentralized, but what we get on-line and via cable is random, obviously stanted or has a vain, "hey, look at me" quality. And, there is a lot of off-putting trickery involved in turning a profit in the new media, of which we news consumers are sick. WP is excellently positioned to use the new media in a way that both commands respect for its neutral, accurate reportage and turns a fair profit. When the avalanche of semi-news and uninformed opinion loses support through some combination of consumer weariness and regulation, the Washington Post could not only remain standing, but stand taller than before.

  • Report this Comment On October 19, 2010, at 6:18 PM, CarrieMike wrote:

    I've heard that Buffet has personal ties to some of his investments, including the Washington Post. I imagine those relationships do influence some of his business decisions. Even an investor of his expertise is vulnerable some of the time!

  • Report this Comment On October 19, 2010, at 10:55 PM, diegorgazzi wrote:

    Yes, indeed if you read "snowball", the book implies that the majority owner of the Washington Post 40 yrs ago, which I don't remember her name (but she died) was Buffett's mistress. From that same book you learn that Buffett had a huge infatuation with the Media (I guess that's why he still loves to be interviewed), and He always wanted to be a reporter. In fact, he was very close to being one profesionally when one of his investigative reporting for another little news paper he owns earned him (and two other gentlemen) the Pulitzer Prize.

    I'm not sure why he almost never sells. He's a follower of Graham and Even Fisher, both of whom had the same philosophy. After reading a lot about Buffett, I can tell he likes to Acumulate money for the simple purpose of just accumulate it. Why sell when the cash a company he buys produces enough money to buy other companies. Even public companies where he doesn't have a controlling share, Wealth is being accumulated in time. Every company that he invests eventually has a stock repurchase program which increases his holding... a lot of the companies he likes also offer dividends.

    Alex, why don't you guys interview Buffett? I'm tired of Fox and CNBC asking the same questions. Let's ask practical questions like, if one is to follow what Buffett and Grahan and Fisher do/did, which is buy and almost never sell, then how do you make a living between the time that you bought and the time you'll eventually sell some shares? I still haven't figure out how he did that in view that he buys and waits 10 years if not more before selling a single share... If anyone has a way of doing that please let me know!

  • Report this Comment On October 20, 2010, at 12:31 AM, TMFAleph1 wrote:

    @diegorgazzi

    'The Snowball' is a great book, no question about it. A lot of interesting detail that allows you to get a better feel for Buffett's psychology.

    Alex Dumortier

  • Report this Comment On October 20, 2010, at 11:05 AM, sdfsdfdsfsd wrote:

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  • Report this Comment On October 20, 2010, at 1:59 PM, biajee wrote:

    Warren Buffett cares a lot about his reputation. He used to say 37 years of reputation can be ruined in 5 minutes, and rebuild this reputation will take another 37 years. So, he is huge on his reputation. And not selling his subsidiary is a huge commitment. For one thing, this reflects his understanding of owning a business. For another thing, this is a live advertisement on his buying new business. Although, Washington Post is still a public company, it's considered to be his subsidiary already. As he was the mentor and friend of Kay Graham. Also, he has physically saved this newspaper company. One big thing is that he said in one of his May meeting that he will neither sell newspapers company, nor would he buy one. For him, he can get the money by selling stocks in WPO. That's all he can get. Does he need this amount of money for a better investment opportunity? No. Does this money can get BRK into a better financial situation? No. On the other hand, by selling WPO, he will lose his reputation, he will lose the ability of partnering with some fantastic company like BYD.

  • Report this Comment On October 21, 2010, at 8:04 PM, TMFAleph1 wrote:

    @biajee,

    Yes, Buffett has long historical, financial and emotional ties to the Washington Post, but this is the first time I've ever heard someone say that the company is considered to be his subsidiary.

    I don't think Buffett thinks of the company in those terms and, given his length of tenure as a WPO shareholder and his service as a director, I don't see how selling his shareholding now would tarnish his reputation.

    Alex Dumortier

  • Report this Comment On October 22, 2010, at 4:14 PM, ikkyu2 wrote:

    Alex,

    I don't pretend to have better insight into Buffett than you or anybody else does, so take this for what it's worth.

    I think that when you're transacting in equity stock like you, I, or occasionally Warren do, - buying a non-control position, holding it for a while, selling it - there are decision points. Decisions are made with the brain and the brain makes decisions based on conscious and unconscious rules and contexts.

    I find that I make decisions that impact my portfolio: I might decide to buy a stock and execute that trade; I might decide to sell a stock and execute that trade; and of course there are many more decisions to not buy and not sell that are made or that get made through passive inaction. If you journal what you do when you do it, and why you do it; and look back later; it can be surprising to learn how your brain actually works with regard to these decisions.

    I think Buffett knows how his own brain works. I think he acts to keep it working optimum.

    Personally, I have a few losers in my own portfolio - stocks that have lost 90+% of their value since I bought them. PTN; JMBA. (The GM went to 0 and got liquidated.) Every time I take a look or contemplate a trade I see them sitting there, reminding me: don't buy a stock that can lose 98% of its value. Looking back over my journal, they've spooked me out of some buys (MINI; ARKR) that would have turned out to be disasters.

    Your mileage may vary :)

  • Report this Comment On October 25, 2010, at 5:18 PM, earleyfool wrote:

    Hello everyone,

    As a new member of the Motley Fool group (started 18Oct2010) I have to say it is a pleasure.

    As to how Buffett makes money in between his buy's and sell's is fairly simple,for Buffett,is something that he learned at a fairly young age and was instrumental in one of his very first stock purchases. As most people who follow Buffett know, he became very familiar with how valuable, and dynamic insurance companies are leading to his weekend trip to GEICO headquarters were he decided to buy his first share's in the company.

    Buffett so loves insurance companies that as we all know he now owns a few insurance companies outright with the most famous probably being GEICO.

    It is no secret of course how insurance works. You pay premiuns reguarly but rarely do you use or takeback any of the money that you pay. If you do there is usally a long time span between when you pay and when you draw out the money. Multiply this concept by thousands upon thousands upon thousands of payments and the insurance company ends up with billions of dollars to use for some time before they have to pay it out. The insurance company invests or buys other companies with this money. And remember, this is a monthly occurence, so you,(In this case Buffett & Munger) have a constant cash flow coming in all year.

    In short Buffett could probably never sell a single share of his holdings and have a steady income for as long as he continues to own his insurance comanies. Of course this income is known as FLOAT. Last I heard(@7yrs ago)Berkshire had over 2BILLION dollars of FLOAT.

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