Celebrating Warren Buffett's $200 Billion Mistake

According to Jason Zweig's excellent resource, This Day in Financial History, today marks the 48th anniversary of a milestone in the annals of value investing. On May 10, 1965, in a New Bedford, MA boardroom, a 34-year money manager named Warren Buffett took control of manufacturer of men's suit linings named Berkshire Hathaway, Inc (BRK.B -0.01%) (BRK.A -0.34%). On that day, Berkshire's stock closed at $18 per share; yesterday, Berkshire's A shares closed at $166,100. Despite that appreciation, Buffett calls Berkshire "the dumbest stock I ever bought." The explanation and the extraordinary story of how Buffett came to control Berkshire are worth the telling. In Buffett's own words, from a 2010 interview with CNBC [my emphasis]:  

"The dumbest stock I ever bought was -- drumroll here -- Berkshire Hathaway, and that may require a bit of explanation. It was early in 1962, and I was running a small partnership, about $7 million [in assets under management] -- they'd call it a hedge fund now. And here was this cheap stock, cheap by working capital standards or so, but it was a stock in a textile company that had been going downhill for years. 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 going to close; they only had a few mills left, but they'd close another one, I'd buy the stock, I'd tender it to them and make a small profit. So I started buying the stock."  

"And in 1964, we had quite a bit of stock, and I went back and went back and visited the management, Mr. Stanton, and he looked at me and said: "Mr. Buffett, we've just sold some mills, we've got excess money, we're going to 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 at $11.50?" And I said: "Mr. Stanton, you have my word that if you do it in the near future, that I will sell my stock at $11.50," and I went back to Omaha. And a few weeks later, I open the mail and here it is: A tender offer from Berkshire Hathaway -- that's from 1964 -- and if you look carefully, you'll see that the price is $11 ⅜. He chiseled me for an eighth. And if that letter had come through with $11 ½, 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, and we went on from there."

"Now that sounds like a great little morality tale at this point, but the truth is, I had now committed a major amount of money to a terrible business. Berkshire Hathaway became the base pretty much for everything that I've done since, so in 1967, when a good insurance company came along, I bought it for Berkshire Hathaway. I really should have bought it for a new entity, because Berkshire Hathaway was carrying this anchor of all these textile assets; so, initially, it was all textile assets that weren't any good, and then, gradually, we built more things onto it. But always we were carrying this anchor; for twenty years, I fought the textile before I gave up, and, if, instead of putting that money into the textile business originally, we just started out with the insurance company, Berkshire would be worth twice as much as it is now. This is $200 billion you can figure it comes about, because the genius here thought he'd run a textile business."

Incidentally, the insurance business Buffett refers to is the National Indemnity Company, an Omaha, NE specialty insurer. In the 2004 Berkshire Hathaway Annual Report, Warren E. Buffett, Chairman, wrote, “Indeed, had we not made this acquisition [National Indemnity Company], Berkshire would be lucky to be worth half of what it is today.”

Thankfully for Berkshire shareholders, while Buffett may have taken a "buy-and-hold" approach to the textile assets, at the holding company level, National Indemnity Company was the first in a long line of outstanding acquisitions that more than made up for the dismal economics of the textile business. The following numbers speak for themselves:

Source: Berkshire Hathaway Annual Letter