Learning from Warren Buffett's 7 Major Investment Errors
Updated
Warren Buffett's name resonates with success, particularly through investments in renowned companies such as Coca-Cola, American Express, Apple, Bank of America, Moody’s, Kraft Heinz, and more. He stands as a global icon, amassing a wealth exceeding USD 100 billion. Beyond his investment prowess, Buffett generously imparts his wisdom to millions worldwide. Among his many famous quotes, one emphasizes the importance of learning from others' mistakes.
Warren Buffett's 7 Major Investment Errors
I) Dexter Shoe Company
- In 1993, Warren Buffet's Berkshire Hathaway acquired Dexter Shoe Company, a decision he later regretted as his worst deal. Buffet made multiple significant mistakes in this acquisition.
- The first error was misjudging Dexter's potential. Berkshire bought Dexter due to its high return on capital employed but failed to consider the competitive threat posed by cheap shoes from countries like China. Buffet acknowledged this oversight in 1999, highlighting the increasing challenge for domestic producers in the face of a market flooded with 93% of 1.3 billion pairs of shoes purchased in the United States coming from abroad.
- The primary lesson here is the necessity of assessing a company's durable competitive advantage before investing. Durable competitiveness has transitioned from a good-to-have factor to a must-have for any business.
- Buffet's second mistake was financing the Dexter Shoe Company purchase with Berkshire Hathaway stock valued at 433 million dollars, rather than using cash. A single share of Berkshire's Class A stock was approximately USD 15,000 in 1993. Today, it is valued at USD 517,000.
- This decision didn't just cost Berkshire shareholders USD 433 million for a company that eventually became worthless; it resulted in a staggering loss of 15 billion dollars for Berkshire's shareholders.
- The crucial lesson derived from this experience is never to sacrifice successful investments to make risky bets.
II) Tesco
- Tesco, a British grocery chain, became a concern for Berkshire Hathaway when the company's ownership stake exceeded 5% by 2012. By 2013, signs of trouble at Tesco became evident, leading Berkshire to reduce its stake to 3.7%, amounting to an investment of nearly 1.7 billion dollars.
- In the subsequent months, Tesco's stock plummeted by nearly 50% due to declining sales, heightened competition from discount retailers, and an accounting scandal that attracted scrutiny from the UK's financial regulators.
- Buffett's mistake lay in hesitating to sell Tesco stocks despite recognizing these troubling signs. This delay resulted in a loss of approximately USD 444 million for Berkshire.
- The crucial lesson from this situation is the importance of conviction when making selling decisions. Just as one should invest with conviction, it is equally vital not to hold onto a stock if confidence in its performance wavers.
III) Energy Future Holdings
- Warren Buffett, known for seeking advice from Charlie Munger in his investment decisions, openly admitted a significant mistake in his 2013 letter. He invested USD 2.1 billion in bonds of Energy Future Holdings Corporation, banking on rising natural gas prices to boost the competitiveness of the coal-based business and yield profits.
- Unfortunately, natural gas prices plummeted from their 2007 levels, leading to substantial losses for Energy Future Holdings. The company declared bankruptcy in 2014, and Berkshire Hathaway sold the bonds at a loss of USD 873 million in 2013.
- Buffett acknowledged his error in assessing the transaction's gain-loss probabilities, emphasizing the importance of seeking a second opinion from trusted advisors or partners when making significant decisions.
- This incident highlights two essential lessons. Firstly, it underscores the risks associated with predicting market trends, whether in natural gas, oil, gold, or individual stocks. Secondly, it emphasizes the perilous nature of investing in high-yield "junk" bonds. While conglomerates like Berkshire Hathaway can absorb losses from such high-risk endeavors, retail investors face financial disaster in the event of a default. Hence, it is crucial to avoid instruments with questionable return on capital, especially in a retail investor's context.
IV) Lubrizol & David Sokol
In 2011, Warren Buffett and Berkshire Hathaway faced severe scrutiny.
- David Sokol, chairman of several Berkshire subsidiaries, recommended Lubrizol Corporation as a potential acquisition to Buffett while he himself owned stocks in the company. Sokol's failure to disclose his stock ownership violated Berkshire's insider trading rules. Despite this, Berkshire acquired Lubrizol for approximately USD 9 billion, and Sokol profited around USD 3 million from the transaction.
- Upon investigation, it became clear that Sokol had been ambiguous about how he acquired Lubrizol stock, neglecting to mention that he purchased shares after meeting with the bankers proposing the acquisition. Buffett emphasized the issue as a matter of ethics, although he initially acknowledged that no one was at fault.
- This situation highlighted the importance of not being excessively trusting in the business world. The lesson here is to maintain a checklist, follow a rigorous process, and be unafraid to ask numerous questions, especially when your reputation is at stake. Taking extra precautions becomes essential in preserving one's integrity and credibility.
V) Amazon
- Up until now, the mistakes we've discussed were all instances of active decisions leading to losses. However, there's a different kind of mistake made by Buffett that falls more under the category of missed opportunities.
- In 2017, Buffett openly admitted that he had been observing Amazon.com for an extended period but never invested in it. In his own words, he confessed, “I was too dumb to realize. I did not think Jeff Bezos could succeed on the scale he has.”
- Buffett had underestimated Amazon's brilliance in two key areas: its dominance in e-commerce and its success in cloud services through Amazon Web Services.
- Buffett's traditional approach didn't align with investing in stocks with high price-earning ratios like Amazon's in 2019. Moreover, he tended to overlook technology companies, considering them beyond his expertise.
- In this context, the significant cost of this missed opportunity becomes apparent. It underscores the necessity of having a well-defined area of expertise. However, it's even more crucial to continuously expand and evolve that expertise over time to seize valuable opportunities.
VI) Google
- The Berkshire Hathaway portfolio notably lacks any shares from Alphabet or Google, a fact that Warren Buffett deeply laments.
- Google initially piqued Buffett's interest due to a Berkshire-owned subsidiary, GEICO, operating in the auto insurance sector. GEICO heavily depends on Google's advertising platform to attract customers.
- Buffett acknowledges that he should have delved deeper into Google's business and long-term prospects. His limited technical understanding might have played a role in missing this opportunity, despite it being right within his immediate purview.
VII) Berkshire Hathaway
- It might surprise you, but Warren Buffett's most significant investment blunder occurred when he bought Berkshire Hathaway in 1962. Back then, Berkshire Hathaway was a struggling textile business, meeting the criteria of Benjamin Graham's cigar-butt investing model.
- Buffett became intrigued by the favorable financial assessment and started purchasing the stock in installments. In 1964, the company's owner, Seabury Stanton, proposed buying Buffett's shares at $11.50 per share. However, the actual offer received was $11.32, which angered Buffett. In retaliation, he acquired a controlling stake in Berkshire Hathaway and ousted Stanton from the company.
- Despite taking revenge, Buffett found himself stuck with a significant investment in a failing business. To this day, he considers it his most regrettable investment. He endured the burden of this failing textile business for an additional 20 years. Buffett admits that had he redirected the cashflows into other ventures like insurance companies, Berkshire would have been worth twice as much as it is now.
- By his estimations, Buffett's decision to invest in Berkshire Hathaway amounted to a $200 billion mistake. The lesson here is clear: emotional decisions have no place in successful investing.
Thank you
Money_Dictators
Warren Buffett's 7 Major Investment Errors
I) Dexter Shoe Company
- In 1993, Warren Buffet's Berkshire Hathaway acquired Dexter Shoe Company, a decision he later regretted as his worst deal. Buffet made multiple significant mistakes in this acquisition.
- The first error was misjudging Dexter's potential. Berkshire bought Dexter due to its high return on capital employed but failed to consider the competitive threat posed by cheap shoes from countries like China. Buffet acknowledged this oversight in 1999, highlighting the increasing challenge for domestic producers in the face of a market flooded with 93% of 1.3 billion pairs of shoes purchased in the United States coming from abroad.
- The primary lesson here is the necessity of assessing a company's durable competitive advantage before investing. Durable competitiveness has transitioned from a good-to-have factor to a must-have for any business.
- Buffet's second mistake was financing the Dexter Shoe Company purchase with Berkshire Hathaway stock valued at 433 million dollars, rather than using cash. A single share of Berkshire's Class A stock was approximately USD 15,000 in 1993. Today, it is valued at USD 517,000.
- This decision didn't just cost Berkshire shareholders USD 433 million for a company that eventually became worthless; it resulted in a staggering loss of 15 billion dollars for Berkshire's shareholders.
- The crucial lesson derived from this experience is never to sacrifice successful investments to make risky bets.
II) Tesco
- Tesco, a British grocery chain, became a concern for Berkshire Hathaway when the company's ownership stake exceeded 5% by 2012. By 2013, signs of trouble at Tesco became evident, leading Berkshire to reduce its stake to 3.7%, amounting to an investment of nearly 1.7 billion dollars.
- In the subsequent months, Tesco's stock plummeted by nearly 50% due to declining sales, heightened competition from discount retailers, and an accounting scandal that attracted scrutiny from the UK's financial regulators.
- Buffett's mistake lay in hesitating to sell Tesco stocks despite recognizing these troubling signs. This delay resulted in a loss of approximately USD 444 million for Berkshire.
- The crucial lesson from this situation is the importance of conviction when making selling decisions. Just as one should invest with conviction, it is equally vital not to hold onto a stock if confidence in its performance wavers.
III) Energy Future Holdings
- Warren Buffett, known for seeking advice from Charlie Munger in his investment decisions, openly admitted a significant mistake in his 2013 letter. He invested USD 2.1 billion in bonds of Energy Future Holdings Corporation, banking on rising natural gas prices to boost the competitiveness of the coal-based business and yield profits.
- Unfortunately, natural gas prices plummeted from their 2007 levels, leading to substantial losses for Energy Future Holdings. The company declared bankruptcy in 2014, and Berkshire Hathaway sold the bonds at a loss of USD 873 million in 2013.
- Buffett acknowledged his error in assessing the transaction's gain-loss probabilities, emphasizing the importance of seeking a second opinion from trusted advisors or partners when making significant decisions.
- This incident highlights two essential lessons. Firstly, it underscores the risks associated with predicting market trends, whether in natural gas, oil, gold, or individual stocks. Secondly, it emphasizes the perilous nature of investing in high-yield "junk" bonds. While conglomerates like Berkshire Hathaway can absorb losses from such high-risk endeavors, retail investors face financial disaster in the event of a default. Hence, it is crucial to avoid instruments with questionable return on capital, especially in a retail investor's context.
IV) Lubrizol & David Sokol
In 2011, Warren Buffett and Berkshire Hathaway faced severe scrutiny.
- David Sokol, chairman of several Berkshire subsidiaries, recommended Lubrizol Corporation as a potential acquisition to Buffett while he himself owned stocks in the company. Sokol's failure to disclose his stock ownership violated Berkshire's insider trading rules. Despite this, Berkshire acquired Lubrizol for approximately USD 9 billion, and Sokol profited around USD 3 million from the transaction.
- Upon investigation, it became clear that Sokol had been ambiguous about how he acquired Lubrizol stock, neglecting to mention that he purchased shares after meeting with the bankers proposing the acquisition. Buffett emphasized the issue as a matter of ethics, although he initially acknowledged that no one was at fault.
- This situation highlighted the importance of not being excessively trusting in the business world. The lesson here is to maintain a checklist, follow a rigorous process, and be unafraid to ask numerous questions, especially when your reputation is at stake. Taking extra precautions becomes essential in preserving one's integrity and credibility.
V) Amazon
- Up until now, the mistakes we've discussed were all instances of active decisions leading to losses. However, there's a different kind of mistake made by Buffett that falls more under the category of missed opportunities.
- In 2017, Buffett openly admitted that he had been observing Amazon.com for an extended period but never invested in it. In his own words, he confessed, “I was too dumb to realize. I did not think Jeff Bezos could succeed on the scale he has.”
- Buffett had underestimated Amazon's brilliance in two key areas: its dominance in e-commerce and its success in cloud services through Amazon Web Services.
- Buffett's traditional approach didn't align with investing in stocks with high price-earning ratios like Amazon's in 2019. Moreover, he tended to overlook technology companies, considering them beyond his expertise.
- In this context, the significant cost of this missed opportunity becomes apparent. It underscores the necessity of having a well-defined area of expertise. However, it's even more crucial to continuously expand and evolve that expertise over time to seize valuable opportunities.
VI) Google
- The Berkshire Hathaway portfolio notably lacks any shares from Alphabet or Google, a fact that Warren Buffett deeply laments.
- Google initially piqued Buffett's interest due to a Berkshire-owned subsidiary, GEICO, operating in the auto insurance sector. GEICO heavily depends on Google's advertising platform to attract customers.
- Buffett acknowledges that he should have delved deeper into Google's business and long-term prospects. His limited technical understanding might have played a role in missing this opportunity, despite it being right within his immediate purview.
VII) Berkshire Hathaway
- It might surprise you, but Warren Buffett's most significant investment blunder occurred when he bought Berkshire Hathaway in 1962. Back then, Berkshire Hathaway was a struggling textile business, meeting the criteria of Benjamin Graham's cigar-butt investing model.
- Buffett became intrigued by the favorable financial assessment and started purchasing the stock in installments. In 1964, the company's owner, Seabury Stanton, proposed buying Buffett's shares at $11.50 per share. However, the actual offer received was $11.32, which angered Buffett. In retaliation, he acquired a controlling stake in Berkshire Hathaway and ousted Stanton from the company.
- Despite taking revenge, Buffett found himself stuck with a significant investment in a failing business. To this day, he considers it his most regrettable investment. He endured the burden of this failing textile business for an additional 20 years. Buffett admits that had he redirected the cashflows into other ventures like insurance companies, Berkshire would have been worth twice as much as it is now.
- By his estimations, Buffett's decision to invest in Berkshire Hathaway amounted to a $200 billion mistake. The lesson here is clear: emotional decisions have no place in successful investing.
Thank you
Money_Dictators
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