Many investors talk about billionaire Warren Buffett with a kind of awe. That is understandable. After all, the ‘Sage of Omaha’ has had an incredible run in the stock market spanning more than eight decades.
His career offers a lot of learning opportunities for us all. But while it is easy to zoom in on what Buffett did well, it is also instructive to learn from some of what he himself has characterised as “mistakes” in his career.
Buffett’s costliest error
Interestingly, what he sees as his costliest mistake was buying Berkshire Hathaway. With its $1.1trn market capitalisation today, that may sound odd. But Buffett’s reasoning here is compelling.
Berkshire was a struggling textile company when he bought it. Trying – unsuccessfully – to turn around that business sapped lots of time and capital.
That matters because of what is known as the opportunity cost. Tying money up in a failing business meant it was unavailable for other far more lucrative investment ideas.
I think this can be a very useful thing for an investor to bear in mind when thinking of committing money to something – what might be the opportunity cost?
Not all mistakes are ‘mistakes of commission’
When people talk about mistakes they have made, they often refer to things they have done. Buffett is a smart enough investor to recognise that there are mistakes like that – “mistakes of commission“, as he calls them, such as the initial purchase of Berkshire I mentioned above.
But he also refers to “mistakes of omission“. He defines these as things he failed to do when he had the chance, that were well inside his circle of competence. One example was failing early on to buy into Google parent Alphabet.
As Buffett’s late partner Charlie Munger explained: “We could see in our own operations how well that Google advertising was working and we just sat there sucking our thumbs, so we are ashamed.”
Buffett and cigar butt investing
Buffett’s early years were spent as a value investor, engaging in what he calls “cigar butt investing.”
As he explains: “A cigar butt found on the street, that only has one puff left in it may not offer much of a smoke, but the bargain purchase price will make that puff all profit.”
That could be successful, but still ultimately a mistake – because of the opportunity cost of missing out on longer-term opportunities that might offer exponential returns.
Under Munger’s influence, Buffett shifted to such opportunities, such as buying into Coca-Cola (NYSE: KO). The company’s strong brand, proprietary formulation, powerful distribution network, loyal customer base and frequent consumption opportunities mean that not only was it a good business, it was one that could (and did) get better over time.
Indeed, Coca-Cola has grown its dividend per share every year for decades.
It has faced challenges along the way. Growing health concerns pose a risk to demand for sugary drinks, for example.
But fundamentally, Coca-Cola when Buffett bought it was a value share in a different way to how he had originally understood that term.
It was not that the share was cheap relative to the company’s assets. Rather, it was cheap relative to what the long-term value of the company would turn out to be, thanks to how it deployed those assets.
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Christopher Ruane does not hold any positions in the companies mentioned.
