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Archive for the 'Mistakes' Category

A Mistake that Warren Buffett Made

Typically, Warren Buffett’s mistakes fall into the omission rather than commission category.

By this, we are not refering to missing out on high tech companies that Warren didn’t buy. He wouldn’t have understood them anyway. Rather, we are refering to business situations that Charlie and Warren can understand and that seem clearly attractive – but in the end they just stood there doing nothing.

Here’s an example:

In early 1988, Warren decided to buy 30 million shares (adjusted for a subsequent split) of Federal National Mortgage Association (Fannie Mae). This would have cost about $350-$400 million.

This was a company that he understood well and was very positive about the company’s future. However after he bought about 7 million shares, the price began to climb. In frustration, he stopped buying. In an even sillier move, he even sold the 7 million shares he owned as he didn’t liked holding small positions.

As of 1991, an estimate of the gain that Berkshire didn’t make – a cool $1.4 billion.

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Since this was written by Warren Buffett in 1990, it refers to the mistakes that he made from 1965-1990. Here’s a summary of what he did wrongly.

Buying Berkshire

His first mistake was buying a textile business. Even though he knew the industry was not promising, he was enticed to buy because it was cheap. While buying cheap shares was rewarding to him in his early years, this strategy was not ideal at all.

If you can buy a business at a sufficiently low price, there should be a point in the future where you can unload it at a decent profit. However, this approach is foolish as the “bargain” price might turn out to be not a bargain at all.

In a difficult business, there are usually many problems that it has to face one after another.

Also, any advantage obtained from a low price is usually quickly eroded by the returns of the business.

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

Management

“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”

Easy Does It

Charlie Munger and Warren Buffett did not learn how to solve difficult business problems. Instead, what they have learnt is to avoid them.

In both business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult.

Of course, there are occassions when tough problems must be tackled. In other instances, a great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable, problem.

His Most Surprising Discovery

He refers to an overwhelming important unseen force in business called “the institutional imperative.” Examples given by Buffett include:

1) An institution will resist any change in its current direction.

2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds.

3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops.

4) The behavior of peer companies, whether they are expanding, acquiring, setting
executive compensation or whatever, will be mindlessly imitated.

All these are not caused by stupidity, but by institutional dynamics.

Business Partners

Buffett learnt to go into business only with people that he liked, trust and admire. While this policy will not ensure success, wonders can be accomplished if this relationship is made with people in business with good economics characteristics.

On the other hand, he will never go into partnerships with people who lack admirable qualities, no matter how good the propects of the business could be.

Publicly Unseen Mistakes

Some of Buffett’s mistakes were not publicly visible. There were a couple of stock and business purchases whose virtues he understood and yet didn’t make. This inaction has cost Berkshire’s shareholders dearly.

Conservative Financial Policies

In Buffett’s view, Berkshire’s consistently conservative financial policies was not a mistake.

Howeever, it was clear that significantly higher leverage ratios would have produced considerably better returns on equity than the 23.8% they averaged.

Even in 1965, if he could have judged there to be a 99% probability that higher leverage would be good (and a 1% chance of anguish), he wouldn’t have liked the 99:1 odds.

Leverage to him is an acceleration of your process. If your action is sensible, you should still get good results.

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Two Mistakes That Warren Buffett Made

Warren’s first mistake was in buying Berkshire. Even though he knew textile manufacturing to be unpromising, he bought because he thought the price looked cheap.

This is akin to the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left may not offer much of a smoke, but that puff is all profit due to the bargain purchase.

This approach is foolish unless you are a liquidator.

Firstly, the original purchase price might turn out to be not cheap. Usually, there will be more problems hidden from the surface.

Secondly, any initial advantage from the purchase price will be quickly eroded by the low returns of the business.

Another mistake that Warren made was in buying a Baltimore department store, Hochschild Kohn. It was bought at a substantial discount to book value and the management was good.

It was sold three years later for about the same price that Warren paid.

Always keep this in mind, “It’s far better to buy a wonderful company at a fair price than to buy a fair company at a wonderful price.” Look for both first-class business and first-class management.