What You Can Learn From 5 Prominent Warren Buffett Mistakes

Warren Buffett rightfully deserves his place among the list of investing greats.

He took over the reins of Berkshire Hathaway 50 years ago in 1965 when it was still just a struggling textile mill. Over the years, Buffett transformed the company into the massive US$350 billion conglomerate that it is today mainly through astute acquisitions of private companies and smart investments in stocks.

As a concrete example of his brilliance, Berkshire’s per-share book value – a proxy for the firm’s real business value – had grown by a compound annual rate of 19.4% from 1965 to 2014.

But despite his success, Buffett has also made his fair share of mistakes. Let’s take a look at five prominent occasions in which Buffett has tripped up, keeping in mind the idea that valuable lessons about investing can be learnt from them.

5. Dexter Shoes

Buffett had purchased Dexter Shoes, an aptly-named shoe manufacturer and retailer, in 1993 for US$433 million with Berkshire stock.

But, it turned out to be a poor investment, so much so that Buffett wrote in his 2007 Berkshire annual shareholder’s letter that “To date, Dexter is the worst deal that I’ve made.” Buffett also mentioned in the same letter one big reason why Dexter had been a horrible error – the use of Berkshire’s stock as currency. Buffett wrote:

“By using Berkshire stock, I compounded this error hugely. That move made the cost to Berkshire shareholders not $400 million, but rather $3.5 billion. In essence, I gave away 1.6% of a wonderful business – one now valued at $220 billion – to buy a worthless business.”

If and when the companies you’re invested in ever issue stock to make acquisitions, it’s important for you to take a hard look at the quality of the business being acquired.

4. Tesco

At the end of 2012, Berkshire had owned around US$2.3 billion worth of Tesco’s stock, making it one of the largest shareholders of the global retail chain. But, Tesco fell into serious trouble in 2014 after years of declining profit and the emergence of an accounting scandal. Buffett eventually decided to part ways with Tesco, but not after suffering a loss of more than US$400 million after tax in total on the investment.

Buffett’s experience with Tesco is a good reminder for investors that scandals can remain unforeseen until they erupt. As a result, some form of diversification when investing is always needed.

3. US Airways

In 2007, Buffett wrote that “If a farsighted capitalist had been present at Kitty Hawk [the legendary place where the first powered airplane flight took place], he would have done this successors a huge favour by shooting Orville down.” This clearly shows his disdain for airlines as a business.

This sentiment of his had likely been coloured by his 1989 investment in the preferred stock of US Airways. The preferred stock seemed like a sweet deal as it carried a 9.25% yield in addition to the option to convert the preferred stock into common stock in two years at a price of US$60 per share. At that time, US Airways was trading at around US$52 apiece.

But, the brutal economics of the airline industry caused US Airways to struggle and despite the great terms Buffett had on the airline’s preferred stock, he only managed to make a profit as a result of luck and a bull market.

Airlines are a tough business to run and that’s important for investors to note.

In Singapore’s context, Singapore Airlines Limited (SGX: C6L) is one of the most iconic companies around. But, it has been struggling for years with low profit margins and returns on equity. As a result, it hasn’t been a great long-term investment: In the decade ended 4 August 2015, Singapore Airlines’ shares have generated an annual total return (where reinvested dividends are factored in) of merely 4.4%.

2. Wal-Mart

Not every mistake is about making an investment in a bad company. Sometimes, it involves great companies too.

Buffett was investing in Walmart’s shares in the 1990s and wanted to buy more than US$200 million worth of shares. At that time Walmart was trading around US$11.50 apiece. But when Walmart’s shares started rising as he was buying, he decided to not continue his purchases.

Those “lost” Walmart shares cost Berkshire some US$10 billion in gains by 2004, according to Buffett’s estimate. For some perspective, Walmart’s shares are currently trading at a price of around US$72 each.

The lesson here? Don’t haggle too much when buying shares of businesses that have the ability to grow materially over time. In the year through 31 January 1996, Walmart had made U$0.60 per share in profit; in the 12 months ended 30 April 2015, Walmart’s earnings per share had rose more than eight-fold to US$4.99.

1. Berkshire Hathaway

According to Buffett himself, his worst investment was actually Berkshire.

It all started in the middle of the 1960s when Buffett started investing in Berkshire’s shares because it was selling for a very low price in relation to its asset value at that time. Eventually, Berkshire’s main shareholder back then, a man named Seabury Stanton, offered to buy Berkshire’s stock at US$11.50 each from Buffett. Seeing that the deal would have given his investment a nice profit, Buffett agreed.

But when Stanton came in with the official offer, the price was just US$11.375. Furious by Stanton’s inability to keep to his promise, Buffett started buying Berkshire’s stock in earnest, eventually acquiring a large-enough stake to oust Stanton.

The problem was, Berkshire’s legacy business at that time – textile manufacturing – had no competitive advantage to speak of and was a cash guzzler. It made for a poor business and ended up being a huge mistake for Buffett.

Buffett even went on record in 2010 to state that had he not been overtaken by his emotions and invested in a good insurance business instead of committing capital into acquiring Berkshire, the firm he’s controlling today (whatever it may be) would be worth nearly twice as much as the US$200 billion that Berkshire was worth back then.

Our emotions can wreak havoc on our investing results. And if even Buffett’s susceptible to sub-optimal investing decisions as a result of being emotionally driven, we ought to find ways to minimise the impacts that our emotions can have on our investing activities.

There're a lot more interesting things about Buffett and investing to talk about and if you'd like to do it in person, you can come meet David Kuo and the rest of the Fool Singapore team on August 15! 

Please join us at Invest FAIR Singapore on 15 August. (Suntec Centre, Booth B-16). Come chat with us at our booth, and see our MAS-licensed Director, David Kuo, give his official SGX investor presentation.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim owns Berkshire Hathaway Inc and Tesco Inc.