This Is 1 Warren Buffett Mistake Investors Should Be Aware Of Right Now

Credit: Terrance Heath

Calling Warren Buffett one of the world’s best investors today wouldn’t be a stretch at all.

Having been the leader of the U.S.-based Berkshire Hathaway since 1965, Buffett has grown the conglomerate’s book value per share (a good proxy for the true worth of the business) by an astounding 19.4% annually over the past 50 years. And, he has done it largely via smart acquisitions of private companies and astute long-term stock market investments.

But despite his achievements, Buffett has made his fair share of mistakes too. And to his credit, he hasn’t shied away at all from acknowledging them through the years. In his 1989 Berkshire annual shareholder’s letter, Buffett recounted an investing mistake he had made earlier in his career – of buying Berkshire. He explains:

“My first mistake, of course, was in buying control of Berkshire. Though I knew its business – textile manufacturing – to be unpromising, I was enticed to buy because the price looked cheap. Stock purchases of that kind had proved reasonably rewarding in my early years, though by the time Berkshire came along in 1965 I was becoming aware that the strategy was not ideal.

If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit.

Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original “bargain” price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces – never is there just one cockroach in the kitchen.

Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre.”

Buffett’s mistake was to focus solely on the cheapness of a stock in relation to its assets without considering the quality of its business. That’s a potential mistake that investors should be aware of, especially in the current market environment.

Stocks in Singapore have declined sharply over the past year, as evidenced by the Straits Times Index’s (SGX: ^STI) near 30% fall. The general market malaise has caused plenty of shares to be valued very cheaply against their assets. In fact, as of 11 February 2015, there were some 211 Singapore-listed stocks that are valued at 0.5 times or less their net tangible assets, according to data from S&P Global Market Intelligence.

Within the 30 constituents of Singapore’s stock market, there are also a handful of companies that belonged to that group of 211. You can see this in the table below:

Company Price-to-net tangible asset value (11 Feb 2016)
Golden Agri-Resources Ltd (SGX: E5H) 0.38
Noble Group Limited (SGX: N21) 0.30
Hongkong Land Holdings Limited (SGX: H78) 0.49

Source: S&P Global Market Intelligence

Some of the 211 really cheap stocks may turn out to be legitimate long-term bargains. But, it may be a mistake for an investor to invest in any of them solely on the basis of them being cheap in relation to their assets. As Buffett had cautioned, the quality of a stock’s business also plays a crucial role in the making of an investing decision.

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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 Chong Ser Jing owns shares in Berkshire Hathaway.