Buffett is legendary, without a doubt, but he’s also not perfect. He makes mistakes just like the rest of us, and he’s remarkably good about admitting them and analyzing them after the fact to see what can be learned (typically in his own very funny and self-effacing way in his annual shareholder letters). He’s able to set ego aside for a rational look at what went wrong.
This trait is invaluable for investors; knowing what you did wrong and doing everything you can to avoid repeating it helps preserve precious capital and improve your returns over the long term. There are times where you’re going to do your analysis, make your decision, and either something changes that renders your conclusion null, or you will have simply made a mistake somewhere in your thinking. It happens to everyone. Like risk, mistakes are an unavoidable part of investing, so it’s best to learn to embrace the lessons that can come from them.
Buffett breaks down his mistakes into mistakes of commission, meaning actions he took that didn’t turn out as he’d hoped, and mistakes of omission, or actions that he regretted not taking. Buffett has said that he’s more bothered by his mistakes of omission than the mistakes he’s actually made, however.
One mistake of omission Buffett has copped to involves retail giant Wal-Mart. In the 1990s, because he wanted to buy shares of Wal-Mart at a particular price and didn’t want to budge from that, he let a one-eighth-of-a-point uptick in the company’s stock price prevent him from purchasing it. Over the long run, he estimates that one mistake cost him $10 billion in potential profits.1 Ouch. That’s quite an expensive omission indeed.
Buffett has said that the first mistake of his investing career was the actual purchase of Berkshire Hathaway itself. When he first started buying shares of the company way back in 1962, it was a textile mill, hanging on to its last gasps as a functioning enterprise. Affected as many manufacturers were by cheap overseas competition, Buffett would try unsuccessfully to turn the business around, until he finally closed its textile operations altogether in 1985. By that point, he’d already begun his strategy of buying insurance companies and using the associated float to invest, under the umbrella of Berkshire, so the transformation of the company was well on its way, despite the floundering manufacturing business.
The frustration Buffett may have felt about Berkshire, and the opportunity cost of having his money tied up in trying to save a losing enterprise, are unfortunate, but this is one mistake that he ended up making right. Berkshire may not have been providing much in the way of suit linings (one of its main offerings) by the time Buffett came along, but it ended up providing him, and his shareholders, an investing vehicle that remains unparalleled. And besides, the names Warren Buffett and Berkshire Hathaway just fit so well together, don’t they? Can you imagine it any other way?
Another of Buffett’s most famous errors is one that provides him the chance in his shareholder letters and in interviews to flog himself for his “Air-aholism.” That mistake is investing in the airline US Airways. Buffett invested in the company in 1989, buying what are known as “convertible preferred shares.” Basically, this means that Berkshire was promised a fat dividend, and could convert its preferred shares into common stock if it so chose at a certain price. At the time of the investment, US Airways was threatened by a takeover attempt, so Berkshire stepping in and investing money in the company was seen as a form of protection for it.
However, nearly from the get-go US Airways (which was officially named just “US Air” until 1996) plagued Buffett. He was blunt about his mistake in his letters to shareholders over the years he was invested in it, calling his analysis of it “superficial and wrong”2 and referring to his decision to invest as an “unforced error.”
Buffett has written of the investment, “Before this purchase, I simply failed to focus on the problems that would inevitably beset a carrier whose costs were both high and extremely difficult to lower.”3 And he “overlooked the crucial point: US Air’s revenues would increasingly feel the effects of an unregulated, fiercely competitive market where its cost structure was a holdover from the days when regulation protected profits. These costs, if left unchecked, portended disaster, however reassuring the airline’s past record might be.”4
There are several interesting things about Berkshire’s, and Buffett’s, investment in US Airways. One is that it came about at a time when Buffett was having trouble finding other opportunities, so he made the mistake of essentially lowering his standards to invest in it.5 One mistake begat another, you could say.
Next, while the investment troubled him and worried him, Berkshire actually ended up making money on the deal, thanks both to the return from the dividends and the fact that shares of US Airways eventually got back to about where he’d invested, so he cashed out. Now, granted, had Buffett chosen to deploy his capital elsewhere, he might well have earned a higher return, but US Airways did not, in the end, turn out to be the supreme disaster it looked like it might be.
An additional and important point for us here is that despite the fact that Buffett ultimately made money on US Airways, he still recognizes it as a mistake. His outcome might not have been bad, but his thinking and his decision-making process were. He is able, then, to separate the “outcome” from the “decision.” Many investors struggle with this, believing, for example, that their worst-performing stocks represent their worst decisions, and vice versa. But a bad decision does not always turn into a bad outcome, and sometimes good outcomes are actually born of bad decision making. Buffett never fooled himself into believing that US Airways was anything other than a mistake, good outcome or no.
Finally, while Berkshire Hathaway is no longer invested in US Airways, it still has a piece of the air travel industry with its wholly owned subsidiary NetJets. NetJets allows people to buy a part of a private jet (known as “fractional ownership”) so that you get the benefit of having a plane all to yourself without the cost of, well, maintaining a plane all by yourself. However, NetJets hasn’t proven to be a big winner for Buffett, and he’s written about it much as he did US Airways, noting that he should have called the “Air-aholics hotline” before investing in it. He’s also said, hilariously, that someone would have done capitalists a favor if they’d just shot down the Wright brothers in Kitty Hawk that fateful day (because over its history the airline industry has reported zero profits in the aggregate).6 In his 2009 shareholder letter, he again revisited the topic, expressing his frustration with NetJets but pointing out that he’d made a management change at the top he was optimistic could correct course for the troubled company and turn around its years of losses.7
One lesson here for the rest of us is that even someone as talented as Buffett not only makes mistakes, but sometimes makes them more than once. When it comes to this particular one, Buffett has said, “If only women could be CEOs of companies that flew planes I think it would be a lot better,” after he came to the conclusion that testosterone was responsible for “Air-aholism.”8
In Buffett’s early days, he partnered with Charlie Munger to buy a Baltimore department store that had seen better times. The store was called Hochschild-Kohn, and returning it to its former glory was an expensive and likely impossible task. As with US Airways, Buffett invested in this business when he was sitting on cash, impatiently looking for stocks to buy in a market that was running away from him.9 Pretty quickly, both Buffett and Munger realized that they’d made a mistake and that retail was no easy feat. After three years of giving it a go, they subsequently sold Hochschild-Kohn to another buyer for roughly what they had paid, to relieve themselves of the burden. While Buffett and Munger’s first deal together looked like an inauspicious beginning, they’ve certainly managed to overcome this early stumble with impressive force.
The US Airways mistake and the Hochschild-Kohn one have two things in common. First, as mentioned, Buffett invested in both of these companies during periods where he was having trouble finding good companies selling at reasonable prices that he wanted to buy. Instead of being patient, he let his trigger finger get the best of him, and so he ended up jumping into businesses he otherwise should have avoided. It can be challenging even for him to do the right thing, which is to wait it out.
NOBODY ESCAPES MISTAKES
In a September 2010 interview about the lessons she learned from one 2008 trade gone bad involving an auto company, Rapuano said, “The two things I did in that mistake that absolutely drive me to distraction are No. 1, I normally save myself from massive errors like bankruptcy and things like that by avoiding businesses like car businesses. I will do turnarounds, I will do messy things, but I don’t usually do that. As I look back on it, I think probably because things that appeared cheap to me at that point were few and far between, at the beginning of ’08, I overdid it on this one. I put way too much of my portfolio in it because it was so cheap and it was so easily explainable. So it was putting too much in it, in a business that wasn’t a good business, so when you are wrong you don’t get saved by the goodness of the business.
“And here’s the additional lesson—probably the one that’s going to be the easiest never to repeat again—I got so much positive feedback on this one. Everyone said it was brilliant. I presented it at the Value Investing Congress and the whole world was like, ‘Oh my God, that’s the best idea.’ I’d talk about it in client meetings and they’d be like, ‘Oh it’s so great. It’s so wonderful. You’re going to make a lot of money on this.’ It was too easy by half.
“Letting your confidence be affected by other people’s reaction to it should have been a giant red flag because normally when I invest in something, especially at the beginning, not after it starts working, everyone thinks I’m wrong. No one ever tells me how great it is.
As Berkshire has grown in size at an astounding rate, Buffett’s been faced more and more with this problem—he often has too much cash and too few places to put it. (Oh, we should all be so tortured, eh?) The market’s overall behavior actually doesn’t even matter that much for Berkshire at this point. Certainly it’s better for Buffett if stocks are trading for rational prices, but it’s Berkshire’s cash coffers that make it difficult for him to invest when and where he wants. Berkshire’s just too big for him to buy meaningful amounts of stock in any companies but the very largest ones at this point, because for them to have any effect on overall results, he can’t just nibble here and there.
As a side point, this is an enormous advantage that you, as an individual investor without the burden of billions of dollars in your bank account and on your balance sheet, have over Warren Buffett. You can find the small, undiscovered, undercover companies that Buffett wouldn’t be able to touch, and you can purchase as many shares of them as you want. You can go places he can’t in the market and look at opportunities he only wishes he could own a part of. So, see, being a billionaire and holding a spot on Forbes’s richest people in the world list (a top 5 spot, to boot) isn’t all that great after all. (Ha.)
But back to Buffett’s mistakes. The second thing that US Airways and Hochschild-Kohn have in common is that neither one seems particularly “Buffett-like.” Neither one seems to have the traits we associate with Buffett today and have already talked about here. There’s no moat to speak of in either the airline business (can you say “the very definition of commodity”?) or the department store business. There are no sustainable competitive advantages with either one. US Airways was also a very capital-intensive business, and while Hochschild-Kohn was less so, when Buffett and Munger invested it still needed lots of improvements to its stores to have any hope of remaining relevant and competitive. Both of the businesses can be described as cash-hungry, not cash-producing. And Buffett is all about the cash-producing companies in the world.
So when he was impatient, and wanting to invest his money somewhere, Buffett both lowered his standards and he chose, in these two cases, companies outside what we think of as ideal Buffett investments. US Airways and Hochschild-Kohn are hardly Coca-Cola or GEICO or See’s Candies or American Express. Staying patient and waiting for the famed “fat pitch” is so important. But even Buffett is fallible here. Should you make a similar mistake, don’t panic. Remember to recognize that you acted when you shouldn’t have and then do your best to stick to a vow not to do it again.
Buffett made two more recent mistakes, both of which could be considered errors in his analysis of the companies and their current and future prospects, and both of which cost Berkshire money. As we mentioned earlier, in 2008 he invested in oil giant ConocoPhillips, thinking that the price of oil would rise. Instead, thanks in part to the financial panic later in that same year, the price of oil dropped, and along with it, ConocoPhillips’ stock price, which was down 37 percent at the end of 2008 from where Buffett purchased shares.11
Around the same time that Berkshire invested in ConocoPhillips, it also bought shares of two Irish banks. Buffett never disclosed publicly precisely which ones were purchased, but his thinking back then was likely that Irish banks weren’t exposed to as much subprime mortgage risk as U.S. banks were, and so they were safer bets at a time when many American banks were going to pieces. Buffett was wrong, and many Irish banks were absolutely slaughtered in the market, with the Irish government even nationalizing some of them. He fessed up to his shareholders about it, disclosing that Berkshire had to write down the value of those two trades to the tune of an 89 percent loss.12 (I myself succumbed to the faulty thinking about Irish banks around this same time, and watched as the shares I purchased in one of them—perhaps one of the very ones Buffett bought—plummeted about the same amount Berkshire’s did. Blimey!)
Here we have two cases of the macroeconomic picture changing so quickly that Buffett’s analysis was turned on its head. Sometimes your thinking, analysis, and objective look at the facts, and your projections for the company’s future, can be right, but your investments can still turn out wrong. That’s disheartening, yes, but it’s also just a reality of investing you need to prepare yourself for. You won’t always be perfect, even if your analysis is. You can’t know every single thing there is to know about a company, and you can’t predict the future with absolute certainty—not even Buffett can. (The world’s just a cold, cruel place, isn’t it?)
Writing of his learning curve in an annual letter to Berkshire shareholders, Buffett said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie [Munger] understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements. That leads right to a related lesson: Good jockeys will do well on good horses but not on broken-down nags.”13
Even Buffett had to learn from his mistakes over the years, and he’s still learning today. The learning never stops, of course. To get the most out of your mistakes, and do your best to ensure they won’t happen again, remember:
• You’re going to make mistakes. We all do. So don’t beat yourself up when you slip up.
• Assess what happened. Did you miss something? Or did market conditions change?
• Think about what you can reasonably do differently in the future. If you bought stock in a company you didn’t truly understand, for example, vow not to do that again.