Today, almost every investor knows that Warren Buffett (Trades, Portfolio) is the CEO of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial). Indeed, it's virtually inconceivable to think of Berkshire without Buffett as the CEO.
However, this was the case before 1965.
Buffett's takeover of Berkshire
When Buffett was running his early investment partnerships, he started buying shares of Berkshire as a net-net situation for the portfolio in 1962. By 1965, he'd acquired a controlling stake in the business.
Buffett described the company as a "delight to own" in his 1965 letter to partners. The average cost of the position was $14.86 and at the end of 1965, the company had net working capital of $19 per share.
Ken Chace was appointed to run the business, improve operations and help Buffett unlock value, as he had done with Dempster Mill a few years prior. As the letter noted:
"Berkshire is a delight to own. There is no question that the state of the textile industry is the dominant factor in determining the earning power of the business, but we are most fortunate to have Ken Chace running the business in a first-class manner, and we also have several of the best sales people in the business heading up this end of their respective divisions. While a Berkshire is hardly going to be as profitable as a Xerox, Fairchild Camera or National Video in a hypertension market, it is a very comfortable sort of thing to own. As my West Coast philosopher says, "It is well to have a diet consisting of oatmeal as well as cream puffs."
But as it turns out, buying the textile business was a disaster.
Buffett described how the scenario unfolded in his 2014 shareholder letter:
"For a time I got lucky: Berkshire immediately enjoyed two years of good operating conditions. Better yet, its earnings in those years were free of income tax because it possessed a large loss carry-forward that had arisen from the disastrous results in earlier years. Then the honeymoon ended. During the 18 years following 1966, we struggled unremittingly with the textile business, all to no avail. But stubbornness – stupidity? – has its limits. In 1985, I finally threw in the towel and closed the operation."
However, Buffett is a fast learner. He realized quickly that Berkshire might not ever live up to its full potential, so in 1967, he bought National Indemnity. This business, as he wrote in his 2014 shareholder letter, was "in my sweet spot: I understood and liked the industry."
While he also admitted that it was a mistake buying National Indemnity as part of Berkshire because it diluted his and his partners' ownership of the business, this decision was ultimately the right one.
And we can learn a lot from it. Admitting when you're wrong and changing course is not a sign of weakness. It is the sign of a good investor. Buffett has always been good at this. If he's decided an investment no longer meets his strict return requirements, he's happy to sell or deploy capital elsewhere.
With Berkshire's textile business, the businessman decided he would not reinvest all of the company's capital back into textiles. Instead, he used it as a cash cow. He took out as much cash as possible and redeployed it back into other more lucrative opportunities.
It has been said that Chace had to ask Buffett to clear every spending request as he did not want more money being put into Berkshire's textile businesses than was needed.
Even though the Oracle of Omaha estimates that buying Berkshire ultimately cost him and his investors upwards of $200 billion, it could have been a lot worse if he hadn't have realized the mistake early on.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
- Seth Klarman on Relative Value and Relative Performance​
- Warren Buffett on Options Trading and Black-Scholes
- Hunting for Deep Value in Frontier Markets
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