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Rupert Hargreaves
Rupert Hargreaves
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Berkshire 2019 Shareholder Letter: Warren Buffett on Mistakes

Key takeaways from Buffett's comments on mistakes

February 26, 2020 | About:

Admitting, acknowledging and moving on from your mistakes is a crucial part of investing. Investors need to be able to recognize when they have made a mistake, learn from it and move on without trying to take revenge on the market. Doing so can be extremely costly.

Not learning from mistakes can be equally as costly, and so can holding onto a losing position. It might be painful to take that loss, but the opportunity cost of not doing so can be far more significant over the long-term.

This is something Warren Buffett (Trades, Portfolio) discussed at length in his 2019 letter to shareholders of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B).

Mistakes and acquisitions

On the topic of acquisitions, Buffett declares in his letter that Berkshire's record of deals "remains largely acceptable," as most deals have produced a favorable result. However, "a meaningful number" have not worked out as expected:

"Fortunately, the fallout from many of my errors has been reduced by a characteristic shared by most businesses that disappoint: As the years pass, the "poor" business tends to stagnate, thereupon entering a state in which its operations require an ever-smaller percentage of Berkshire's capital. Meanwhile, our "good" businesses often tend to grow and find opportunities for investing additional capital at attractive rates. Because of these contrasting trajectories, the assets employed at Berkshire's winners gradually become an expanding portion of our total capital.

As an extreme example of those financial movements, witness Berkshire's original textile business. When we acquired control of the company in early 1965, this beleaguered operation required nearly all of Berkshire's capital. For some time, therefore, Berkshire's non-earning textile assets were a huge drag on our overall returns. Eventually, though, we acquired a spread of "good" businesses, a shift that by the early 1980s caused the dwindling textile operation to employ only a tiny portion of our capital."

Buffett has acknowledged several times in the past that buying Berkshire was his biggest mistake. Still, as the statement above suggests, he admitted this fact and quickly began to build out the business away from its core textile operations.

Berkshire's previous management did not understand the company's problems, and they continued to spend millions trying to turn the operation around with little success. As Buffett went on to demonstrate, it was better to take the loss and move on. He eventually shuttered the textile operations entirely, which allowed Berkshire to shrug off the capital drain.

Two case studies

If Buffett had continued to fund this struggling business, it is unlikely that the conglomerate would be as big as it is today. What's more, if he hadn't realized early on that the textile operation was never going to live up to the previous management's high expectations, we might have never heard of the investor. He could have ended up in a similar situation to Eddie Lampert with Sears.

For years, Lampert has been trying to turn around the struggling department store, with little success. Despite spending billions of dollars on the business, shutting stores, spinning off non-core operations and selling real estate, the threat of bankruptcy was always overshadowing the company.

If Lampert and Sears' previous management had acknowledged the fact that the company was not going to survive in its current form, they could have used capital from operations to diversify the group.

Buffett's experience with Berkshire is not entirely the same as that of Lampert and Sears, but the two case studies have several similarities.

Above all, they clearly show why it is vital to acknowledge your mistakes quickly, cut losses and move on. Throwing good money after bad is never an acceptable investing strategy.

Disclosure: The author owns shares in Berkshire Hathaway.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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