Buffett's 3 Mistakes of 2011

Warren Buffett's Berkshire Hathaway (NYSE: BRK-A  ) (NYSE: BRK-B  ) improved its per-share book value by 4.6% last year and beat the benchmark S&P 500 (including dividends) by 2.1%. While the year was positive, in his annual shareholder letter Buffett admitted to a few mistakes from which we, as small investors, can learn. What exactly did Buffett get wrong?

Buffett's error in energy
First, Buffett explains:

A few years back, I spent about $2 billion buying several bond issues of Energy Future Holdings, an electric utility operation serving portions of Texas. That was a mistake -- a big mistake. In large measure, the company's prospects were tied to the price of natural gas, which tanked shortly after our purchase and remains depressed.

The bonds are currently worth $878 million, but if natural gas prices remain low, the bonds could be worth zero. As Buffett says himself, he "totally miscalculated the gain/loss probabilities."

As small investors, we often think about a stock's upside potential without diving into what could go wrong. Commodity prices, and stocks with fortunes tied to commodity prices, are difficult to predict. For example, CARBO Ceramics (NYSE: CRR  ) , a maker of proppant for fracking, took a 30% dive in stock price from its January high after announcing that sales in the Haynesville shale play dropped 70% because of less demand for natural gas drilling. While this pullback might have been hard to foresee, now CARBO could represent an enticing buy with even less downside potential.

Buffett's poor prediction
Second, Buffett discusses:

Last year, I told you that "a housing recovery will probably begin within a year or so." I was dead wrong. We have five businesses whose results are significantly influenced by housing activity.

While admitting to his misplaced optimism, he remains bullish on the future of housing, but this time does not put a timeline to his forecast. And with the latest Case-Shiller index reporting housing prices 4% lower in 2011 than the previous year, very few can be confident in calling the bottom of the housing market. But as Fool blogger Erin McBride explains, Toll Brothers (NYSE: TOL  ) and other homebuilder stocks can help predict where housing is headed. While revenues for Toll Brothers were down 4% in the latest quarter compared to last year, net signed contracts rose 45%. Perhaps Buffett's quip that "living with in-laws can quickly lose its allure" is ringing true.

Buffett's less-than-attractive acquisitions
Third, Buffett describes his manufacturing, service, and retailing operations as follows:

This group of companies sells products ranging from lollipops to jet airplanes ... a few, however, have very poor returns, a result of some serious mistakes I made in my job of capital allocation. These errors came about because I misjudged either the competitive strength of the business being purchased or the future economics of the industry in which it operated. I try to look out ten or twenty years when making an acquisition, but sometimes my eyesight has been poor. Charlie's has been better; he voted no more than "present" on several of my errant purchases.

And just like Buffett, we can misallocate the capital in our own portfolios. However, with the help of another's insight we can make better choices. As small investors, we may not know anyone of Charlie Munger's caliber, but we can take the example of Peter Lynch, who after seeing his wife purchase and rave about a pair of Hanesbrands (NYSE: HBI  ) L'eggs pantyhose, realized the market opportunity and rode the stock up to a 30-bagger. Without his wife's input, Lynch would never have heard of L'eggs, and would have missed out on a great stock.

If you're looking for great stocks, we've got one for you to take a look at. Read this special report to discover "The Motley Fool's Top Stock for 2012." It's completely free but available for a limited time, so click here to read it today.

Fool contributor Dan Newman wonders how Buffett will perform in his newspaper-throwing competition at the annual shareholder meeting. He also holds no shares of the companies mentioned above. Follow him @TMFHelloNewman. The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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