Warren Buffett's Letters - His Worst Mistake, 1965

02Apr 2020 by beatytc No Comments

This is the first post in a series which will explore the successes, failures, and teachings of Warren Buffett through his annual Berkshire Hathaway letters to shareholders.

Q: How Do I Learn to be an Investor?

A: Learn From the Best!

Although finances are complicated and don’t come easily to many of us, myself included, there are experts out there who are actively interested in teaching us. Fortunately, one of the most prolific and successful educators is Warren Buffett himself, who’s been us his style of investing through his annual shareholder letters since 1965.

Take a guess: What would Warren Buffett say is his worst investing mistake? In a 2010 interview with Squawk Box on CNBC, he gave a surprising answer – Berkshire Hathaway! There are many lessons in this interview, lets dig in and see what we can find.

Birth of Berkshire

The Berkshire Hathaway Company was created in 1955 by a merger of textile companies with histories dating back to the early 1800s. In the 1930’s, Berkshire was a monster, accounting for 25% of the United States’ fine cotton textile production. As textile manufacturing became a global industry, Berkshire Hathaway began to have stiff competition from cheaper competitors from overseas. The book value (total assets – total liabilities) of each share of stock at the end of 1955 was $22.40. In 1964 this book value had eroded to $19.46.

Warren Buffett first starting buying into Berkshire Hathaway in 1962. In Mr. Buffett’s words, he found the company “cheap” by working capital standards. According to TheStreet, he began buying shares in 1962 for $7.60 – more than 60% less than the book value.

In the Squawk Box interview Buffett states he was willing to sell his shares for $11.50, or a 50% profit. When he was low-balled (by 1/8th of a dollar, or about 12 cents per share), he began aggressively buying the company and gained a controlling interest in the company.

The Biggest Mistake of his Life

So why was this such a big mistake? Buffett answers this himself, “I had now committed a major amount of money into a terrible business…. And for 20 years, I fought the textile business before I gave up. Instead of putting money into the textile business originally, [if] we just started out with the insurance company, Berkshire would be worth twice as much as it is now.” He calculated this to be a $200 billion mistake in 2010.

What Can We Learn Here?

To my knowledge, Buffett had no prior experience or particular interest in the textile industry. Buffett was using methods he had learned from Billy Graham, sometimes called “Cigar Butt Investing.” Essentially, if you find a company selling at a discount to its “book value,” you buy shares regardless of the strength of the company. If the shares increase in value close to book, you sell them at a profit. Many of these companies, however, will fail. The idea is to aggressively buy the shares as the price drops until you gain a controllable stake. At that point, you can sell off the company’s assets, pay off any liabilities, and the remainder is your profit. In this case, buying a company with assets worth $19/share for $7/share seems like an excellent idea.

This did not work here. This may be due, at least in part, to the human cost of shutting down a company as large as Berkshire Hathaway in the 60s. Buffett goes on to explain the high quality of people working in the company, and mentions repeatedly the importance of Berkshire to the local economies. Despite 20 years of trying to right the ship, the final textile operations were shut down in 1985.

Buffett goes on to teach us, “if you get in a lousy business, get out of it…. You don’t want to buy things that are cheap. You want to buy things that are good. It’s much better to buy something that’s good at a fair price, than something that is cheap at a bargain price.”