Unlike many investors, he admits and mostly corrects his errors. He discerns two types; knowing their differences can spare you much grief.
Sometime in the mid-1990s (I recall vaguely but can’t find the quote), Alan Cameron, who at that time headed the Australian Securities Commission (ASIC’s predecessor), defined an experienced investor as one who accumulates plenty of errors over a long and successful career.
Warren Buffett, who turned 94 on 30 August, has been an investor since his early teens. That’s more than 80 years of experience. His ethics and methods have rightly been minutely detailed and widely celebrated, and he gets my vote as the most consequential and successful investor since the 1950s.
His record requires no defence; yet during that time he’s confessed to approximately two dozen mistakes. If we can learn from our own errors, we can learn even more from his. In this article, I list, categorise and assess them.
Buffett’s Biggest Mistake by Far
What’s been the costliest? In 2010, he stated that “the dumbest stock I ever bought was – a drum roll, please – Berkshire Hathaway.”
When Buffett’s investment partnership began to acquire its shares in 1962, recounts Roger Lowenstein in Buffett: The Making of an American Capitalist (Random House, 2008), it was New England’s biggest producer of textiles. Although its roots lay in the late-19th century, it was a recent creation: in 1955, Hathaway Manufacturing Co. (founded in 1888 and based at New Bedford, Massachusetts) and a smaller rival, Berkshire Cotton Manufacturing Co. (founded at Providence, Rhode Island, in 1889, which in 1929 became Berkshire Fine Spinning Associates), merged. The fortunes of the new entity, Berkshire Hathaway, Inc. (hereafter “Berkshire”), didn’t henceforth improve: it usually lost money, and when it didn’t it mostly broke even.
Yet Buffett believed that its shares were undervalued; specifically, it would return to steady profitability, and the price of its shares rise, as its smaller and even more unprofitable competitors closed. His partnership bought its shares at an average of $7.50 – a significant discount, according to Berkshire’s entry at Britannica.com, to the company’s per-share working capital of more than $10 and equity per share above $20 – and over the next two years accumulated ever more.
In 1963 Buffett’s partnership became a major shareholder – and he realised that his thesis was false. Textile manufacturers in Southern states and other countries, thanks to more modern machinery and lower wages, were inherently more efficient – and thus profitable – than Berkshire ever could be; as a result, the textile industry in New England and eventually the South would steadily weaken and eventually disappear.
In 1964, Buffett therefore readily agreed to a verbal offer from Seabury Stanton, Berkshire’s president (CEO), that Stanton buy the partnership’s stake for $11.50 per share. That was well above the shares’ price at the time. A few weeks later he received Stanton’s written tender offer – for just $11.375. In response, an angry Buffett launched the only hostile takeover of his career.
By May 1965, Buffett had acquired 49% of Berkshire’s shares at an average price of $15 per share. He then ejected Stanton and installed himself as Chairman – and for the next two decades strove in vain to maintain Berkshire’s textile operations. Simultaneously, and far more successfully, he began to diversify its capital out of textiles, and thereby established the basis of the colossus whose market capitalisation and total assets now exceed $1 trillion.
Why was Buffett’s acquisition a mistake? In his words, “Berkshire was carrying this anchor, all these textile assets. So initially, it was all textile assets that weren’t any good. And then, gradually, we built more things on to it. But always, we were carrying this anchor. And for 20 years, I fought the textile business before I gave up … (If) instead of (investing in) the textile business originally, we just started out with the insurance company (National Indemnity, which was its first big acquisition), Berkshire would be worth twice as much as it is now.”
Buffett has estimated that over the 45 years from 1965 the purchase of Berkshire cost him and his investors at least $200 billion. If he’s right, then over the past 60 years the opportunity cost has zoomed to $1 trillion.
“If you look at taking that same money that I put into the textile business and (instead put) it into the insurance business … we would have a company that (would in 2010 have been worth) $200 billion.”
It’s hugely ironic: Buffett’s purchase of the company with which he’s become indelibly associated is by far his biggest mistake (see “Warren Buffett’s $200B Berkshire Blunder and the Valuable Lesson He Learned,” CNBC, 18 October 2010 and “Warren Buffett’s failures: 15 investing mistakes he regrets,” CNBC, 15 December 2017).
What’s the lesson? “I would say … if you get (into) a lousy business, get out of it. I mean, (buying Berkshire) was a terrible mistake … I’ve always said that if you want to be known as a good manager, buy a good business. And everyone will think you’re smart … If you think you’re a managerial genius, just try yourself in a bad business.”
“I’ve actually put a line in my annual report (in 1985) … ‘When a manager with a reputation for brilliance meets up with a business with a reputation for bad economics, it’s the reputation of the business that remains intact.’” Mere intellect, in other words, won’t reverse the fortunes of a business on the wrong side of adverse economic trends.
Two Kinds of Errors
Buffett distinguishes two kinds of investment mistakes:
1. Errors of commission are actions (decisions to investment) which produce losses and destroy capital. They thereby reduce the wherewithal available for profitable investments.
2. Errors of omission are decisions (failures to act and grasp opportunities for profitable investment, or premature sales of investments) which produce foregone gains.
He’s acknowledged that he made one of his worst investment decisions when, at 21 years of age, he plunged $2,000 – one-fifth of his net worth – into a 50% interest in a very small (Sinclair) petrol station across the road from a major (Texaco) competitor. Texaco’s enormous size relative to Sinclair’s gave it considerable economies of scale. In plain English, Texaco could profitably sell more fuel more cheaply than Sinclair, and there was “nothing we could do to change that.”
Buffett lost his entire investment but he hadn’t yet learnt his lesson. Like his later acquisition of a textile manufacturer unable to compete with cheaper producers, his decision to buy the petrol station unable to compete with cheaper sellers was clearly an error of commission.
To a group of students at the University of North Carolina in 1998, when his net worth was ca. $30 billion, he estimated that “the opportunity cost on that (failed petrol station investment) is about $6 billion right now … It makes me feel good when my Berkshire goes down, because the (opportunity) cost of my Sinclair Station goes down, too.”
At present, Buffett’s net worth is approximately $145 billion. Accordingly, the opportunity cost of this failed investment has ballooned to $145 billion × 0.20 = $29 billion. The greater is a loss as a percentage of one’s net worth, and the greater is the subsequent growth of net worth, the higher the opportunity cost an error becomes.
What about Buffett’s errors of omission? He also told students at UNC in 1995 that “we owned 5% of the Walt Disney Co. in 1966. The whole company was selling for $80m, debt free: $4m bought us 5% of the company. Berkshire purchased Disney’s shares at a split-adjusted price of $0.31, and not long thereafter sold them at $0.48. In the mid-1990s, Berkshire acquired 20,000,000 shares of Disney at $65 as part of the latter’s merger with Cap Cities/ABC. Buffett’s premature sale in the 1960s didn’t crystallise a loss; over time, however, it became apparent that it was a huge profit foregone. “Oh, well,” Buffett sheepishly told Fortune magazine (4 April 1996), “it’s nice to be back.”
He’s learnt from his mistakes – eventually. Airlines demonstrate that even he sometimes needs to commit multiple mistakes to learn a single lesson.
Even Buffett Has Repeatedly Committed the Same Error
“Any man can make mistakes,” said Marcus Tullius Cicero, the Roman statesman, “but only an idiot persists in his error.” Given his overall long-term record, that criticism of Buffett is much too harsh. On the other hand, it’s not completely inappropriate. In 1952, he lost his entire 50% stake in a poor business which before long failed. A decade later, he acquired a 49% interest in a poor business whose loss-making operations he eventually closed.
In 1989, when Berkshire purchased $385m worth of USAir’s convertible preference shares, he made the same mistake a third time. In 1994, it wrote down their value by 75%. Reflecting on this blunder in an address to the New York Society of Security Analysts, he stated: “frankly, no airline is going to be a wonderful business.” In his talk at UNC, he famously explained why airlines are anything but an investor’s friend:
At Kitty Hawk, North Carolina, on 17 December 1903 Orville and Wilbur Wright achieved the first powered aeroplane flight. “Just think if you’d been there … and all of a sudden this vision hits you that tens of millions of people (per year) would be doing this all over the world someday … You’d think ‘my God, this is something to be in on.’”
Yet the reality has been diametrically different: “despite (investing) billions … of dollars, the net return to owners for the entire airline industry … is less than zero.” Over the past quarter-century, nothing much has changed: in 2022, McKinsey & Co. found that “the airline industry has failed to earn its cost of capital in every year of its existence.” Buffett’s conclusion is evocative:
“If there had been a capitalist (at Kitty Hawk that historic day in 1903, he) should have shot down Wilbur. One small step for mankind and one huge step back for capitalism.”
Buffett has attributed his purchase of USAir’s shares to “temporary insanity.” How will he avert any future attack? “So now I have this (emergency) number, and if I ever have the urge to buy an airline stock, I dial this number and I say my name is Warren Buffett and I’m an airoholic. This guy (at the other end of the line) talks me down …”
In 2016, however, Berkshire revealed stakes in the sector which Buffett had shunned over the previous 20 years. By December 2019, it owned 42.5 million (10% of the total) shares of American Airlines, 58.9 million shares (9% stake) of Delta Airlines, 51.3 million (10%) Southwest Airlines shares and 21.9 million (8%) of United Airlines shares. Collectively, Berkshire paid ca. $4 billion for these shares.
Why did Berkshire buy them? Years of consolidation following post-bankruptcy mega-mergers and sharp declines of fuel prices in 2016-2019 helped airlines to generate huge profits. In 2019 the industry in the U.S. posted its tenth consecutive year of profits and was preparing for even greater demand for travel early in 2020. Then COVID-19 erupted. Airlines scrambled to conserve cash, slashed routes, parked hundreds of planes in the Arizona desert and urged employees to take unpaid and partial leave.
From January to May 2020, when Berkshire sold them, American Airlines’ shares plunged 63%, Delta’s 59%, Southwest’s 46% and United’s 70%. It thereby lost ca. $2.4 billion – almost 60% of its original outlay.
Buffett discussed this divestment at Berkshire’s AGM in 2020. He made an “understandable mistake … When we bought (airlines in 2016), we were getting an attractive amount for our money … It turned out I was wrong …” (see “Warren Buffett says Berkshire sold all its airline stocks because of the coronavirus,” CNBC, 2 May 2020).
Learning from Buffett’s Mistakes: Four Generalisations
”If you keep track of your mistakes,” wrote Todd Finkle in Warren Buffett: Investor and Entrepreneur (Columbia University Press, 2023), “it is possible to identify blind spots and correct for them.” Using Finkle’s list in Chap. 10 of his book as a basis, Table 1 compiles Buffett’s 25 biggest investment mistakes in chronological order (I’ve merged #16’s two errors into one). Buffett has acknowledged that each was a mistake. From these mistakes I derive four generalisations (in increasing order of importance).
Table 1: Warren Buffett’s Top 25 Investing Mistakes
Generalisation #4: on only one occasion has Buffett invested on the basis of a tip (as opposed to his own enquiries and analysis), and only once since the mid-1960s has he failed to seek Charlie Munger’s assessment of a potential investment. On each of these occasions, an error of commission occurred (see also Stock tips are for patsies – are you a patsy? 12 February 2024).
In sharp contrast, on the scores of occasions when he’s conducted due diligence and consulted Munger, Berkshire and its shareholders have profited immensely. The lesson is obvious: you MUST think for yourself; equally, you MUST test your ideas against an intelligent sceptic. In 1991 The Los Angeles Times quoted Munger: “Buffett believes (that) successful investment is intrinsically independent …”
- How much attention does Buffett pay to brokers? “Never ask the barber if you need a haircut.”
- What about ratings agencies? “We don’t make judgments based on (their) ratings. If we wanted Moody’s and Standard & Poor’s to run our money, we’d give it to them.”
- Does Buffett heed central bankers’ continual prognostications? “If Fed chairman Alan Greenspan were to whisper to me what his monetary policy was going to be over the next two years, it wouldn’t change one thing I do.”
- What about market forecasts? They “usually tell us more of the forecaster than of the future.”
- What about everybody else? Over the decades, a stream of people has requested that Buffett back their ideas. Among his tartest retorts: “with my ideas and your money, we’ll do OK.”
In short, Buffett urges, “you have to think for yourself. It always amazes me how (supposedly) high-IQ people mindlessly imitate. I never get good ideas talking to other people.”
In 1980, Buffett told The Omaha World-Herald that the independent investor must “have knowledge of how business operates and the language of business (accounting), some enthusiasm … and qualities of temperament which may be more important than IQ points. These (attributes) will enable you to think independently and to avoid various forms of mass hysteria that infect investment markets from time to time.”
Generalisation #3: five of Buffett’s eight errors of omission (63%) are premature (with the benefit of hindsight) disposals of investments.
This pattern reconfirms a pillar of Buffett’s approach to value investing: buy good businesses at great prices, and preferably exceptional businesses at reasonable prices, and hold them indefinitely. On the numerous occasions when he’s acted accordingly, Berkshire and its shareholders have profited immensely; on the comparatively very rare occasions when he hasn’t, large gains have been foregone.
“We like to buy businesses,” he told The Omaha World-Herald on 21 May 1986. “We don’t like to sell, and we expect the relationships to last a lifetime.” In U.S. News & World Report on 20 June 1994, he went even further: “my favourite time frame for holding a stock is forever.” He so deplores short-term trading that he’s proposed a tax of 100% on the profits from stocks held less than one year (see “Buffett-Watchers Follow Lead of Omaha’s Long-Term Stock Investor,” The Washington Post, 2 October 1987).
Generalisation #2: eight of Buffett’s 17 errors of commission (47%) have taken the form of an insufficient appreciation of adverse structural trends affecting businesses. In other words, these businesses’ franchise was weak; their “moats” were narrow and shallow.
The phrase “economic moat,” which Buffett has popularised, refers to the existence and durability of a business’s ability to protect its profitability. Like a medieval castle, the moat (durable competitive advantage) defends those inside the fortress (profits) from outsiders (competitors). At his talk at UNC, Buffett used Gillette as an example of a company whose moat is wide and deep:
“There are 21 to 21 billion razor blades used in the world (per) year. Thirty percent of those are Gillette’s, but 60% by value are Gillette’s. They have 90% market share in some countries … Now, when something has been around as long as shaving and you find a company that has both … innovation … plus distribution power, and the position in people’s minds … you go to bed feeling very comfortable just thinking about two and a half billion males with their hair growing while you sleep.”
Financial and other difficulties can afflict companies which possesses formidable moats. Crucially, these difficulties don’t permanently impair its competitive advantages; for this reason, these situations have been among Buffett’s most remunerative.
Late in 1963, for example, the “salad oil scandal” caused losses of more than $180 million (equivalent to $5.75 billion today) to corporations including American Express and Bank of America. Yet as Buffett recounted in an address to Columbia University’s Business School in 1985, the scandal “did not hurt (AmEx’s) franchise of the travellers’ cheque or credit card. It could have ruined (its) balance sheet … but … American Express with no net worth was (still) worth a tremendous amount of money.”
Nothing, of course, lasts forever; just as technological and other developments eventually rendered medieval castles and their moats obsolete, durable competitive advantages aren’t permanent.
In the early-1960s, Buffett overlooked the developments that were dooming America’s textile industry; in contrast, in 1986 he clearly anticipated the rising tide of problems that by the turn of the century would begin to engulf (and has now swamped) the television and newspaper industries: “essentially, TV had a lot of untapped pricing power many years ago, and they used it all up … So the ability to price is not there to the same degree. I do not see galloping revenue beyond inflation in the network business; for years, they were getting it and they developed a way of life that was predicated upon it. And now you’re seeing an adjustment.”
Generalisation #1 and Conclusion
The Irish playwright, George Bernard Shaw, regarded mistakes positively: “a life spent making mistakes is not only more honourable, but more useful than a life spent doing nothing.” The ancient Greek philosopher, Plutarch, regarded them as neutrally, but as means to a desirable end: “to make no mistakes is not in the power of man, but from their errors and mistakes the wise and good learn wisdom for the future.”
Applied to investment, Buffett regards them negatively. “Do not make mistakes for the fun of it, but rather avoid mistakes (and learn from others’ mistakes) … You must do (only) a very few things right in your life so long as you do not do too many things wrong …
Applied both to life generally as well as investment specifically, Buffett has long maintained that his mistakes of omission have been much more “bothersome” than his errors of commission. “The mistakes you don’t see in our case are way bigger than the mistakes you see,” he told students at UNC in 1995. “The most important mistakes are ones of omission – those that … are missed opportunities,” Todd Finkle quoted him in Warren Buffett: Investor and Entrepreneur (Columbia University Press, 2023). “The things I needed to do … but did not do them, will constitute my biggest mistakes in life.”
Elon Musk agrees. On more than one occasion he’s stated that people tend to over-emphasise the risk of doing some things and underestimate the risk of not doing them. In other words, they fear errors of commission much more than errors of omission.
Table 1 categorised each of Buffett’s 25 biggest mistakes as either an error of commission or of omission. Most (17 of 25 or 68%) have been mistakes of commission; just 8 of 25 or 32% are errors of omission.
Generalisation #1: anyone who contradicts Buffett and Musk requires compelling evidence, so here goes: although #16 likely ranks among his costliest (in gains foregone), if Table 1 is valid and complete then more than two-thirds of his investment mistakes have actually been errors of commission; fewer than one-third have been errors of omission.
The implications are profound. Firstly, given the information to hand at a particular point in time, the overall risk which inheres in a series of decisions (such as investments over time) cannot be minimised or even reduced. In this general sense, risk cannot be “managed.” Secondly, poor choices stemming from false premises, invalid reasoning and unreliable evidence can increase the series of decisions’ total number of errors – and thereby magnify the likelihood and magnitude of loss.
Thirdly, some mistakes are subjectively more undesirable than others; additionally, investors can choose to increase the likelihood that they incur less intolerable mistakes in order to mitigate the probability that they commit more objectionable ones. Only in this limited but crucial respect can risk be “managed.” Accordingly, decisions whether or not to invest inevitably entail not just objective consequences but also subjective and ethical considerations.
These implications require extensive elaboration. My next article will therefore detail Leithner & Company’s approach to risk and its management. Many of the uninitiated will find it paradoxical and even perplexing: we strive to reduce our overall number of errors – and therefore accept and even welcome a high rate of certain kinds of errors.
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