The Biggest Mistake of Warren Buffett’s Career

Warren Buffett is a hero to many investors, myself included.  His record speaks for itself: 18.3% annualized returns in Berkshire Hathaway’s ($BRK-A) book value over the past 30 years compared to just 10.8% for the S&P 500.  And his returns in the 1950s and 1960s, when he was running a much smaller hedge fund, were even better.

Mr. Buffett is also quite generous with his investment wisdom, sharing it freely with anyone who cares to listen.  But as with most things in life, failure is a better teacher than success.  And Mr. Buffett has had his share of multi-billion-dollar failures.

You want to know the biggest mistake of Buffett’s career?

By his own admission, it was buying Berkshire Hathaway!

Everyone assumes that Buffett’s decision to buy Berkshire Hathaway was a typical Buffett stroke of genius.  Nothing could be further from the truth.

We like to think of Warren Buffett as the wise, elder statesman of the investment profession, but Buffett too was young once and prone to the rash behavior of youth.  And Berkshire Hathaway was not always a financial powerhouse; it was once a struggling textile mill.

Buffett had noticed a trading pattern in Berkshire’s stock; when the company would sell off an underperforming mill, it would use the proceeds to buy back stock, which would temporarily boost the stock price. Buffett’s strategy was to buy Berkshire stock each time it sold a mill and then sell the company its stock back in the share repurchase for a small, tidy profit.

But then ego got in the way.  Buffett and Berkshire’s CEO had a gentleman’s agreement on a tender offer price.  But when the office offer arrived in the mail, Buffett noticed that the CEO’s offer price was 1/8 of a point lower than they had agreed previously.

Taking the offer as a personal insult, Buffett bought a controlling interest in the company so that he could have the pleasure of firing its CEO.  And though it might have given him satisfaction at the time, Buffett later called the move a “200-billion-dollar mistake.”

Why?  Because Buffett wasted precious time and capital on a textile mill in terminal decline rather than allocate his funds in something more profitable—in his case, insurance.

By Buffett’s estimates, had he never invested a penny in Berkshire Hathaway and had instead used his funds to buy, say, Geico, his returns over the course of his career would have been doubled.  Berkshire will still go down in history as one of the greatest investment success stories in history, of course.  But it was a terrible investment and a major distraction that cost Buffett dearly in terms of opportunity cost.

What lessons can we learn from this?  I’ll leave you with two quotes from Buffett himself:

“If you get into a lousy business, get out of it.”

“If you want to be known as a good manager, buy a good business.”

In trader lingo, cut your losers and let your winners ride.  Holding on to a bad investment wastes good capital and mental energies that would be better put to use elsewhere.

Thank you, Mr. Buffett, for sharing your failures with us.  Your willingness to do so is one of the reasons we love you.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.