Regular readers of my articles will know that I like to spend a lot of time dissecting the mistakes of well-known investors. I do this because I believe we can learn more from mistakes than successes, especially when evaluating how an investor moved on from the error.
Every investor makes mistakes. It's just part of the process. However, survivorship bias means we often overlook mistakes in favor of concentrating on successes.
Everyone wants to know about Buffett's most successful investments, but no one is really interested in his biggest losses. The same goes for other high-profile investors, although it's not limited to high-profile investors. It's also worth considering the stakes of investors who have fallen out of the limelight, which helps overcome survivorship bias.
Buffett's latest mistake
In his 2020 letter to shareholders, the Oracle of Omaha admitted that his latest mistake was paying too much for Precision Castparts. In Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) 2020 full-year earnings results, the corporation announced an $11 billion write-down for this business, which Buffett described as "almost entirely the quantification of a mistake I made in 2016." He went on to add:
"That year, Berkshire purchased Precision Castparts, and I paid too much for the company. No one misled me in any way – I was simply too optimistic about Precision Castparts's normalized profit potential. Last year, my miscalculation was laid bare by adverse developments throughout the aerospace industry, Precision Castparts's most important source of customers. In purchasing Precision Castparts, Berkshire bought a fine company – the best in its business. Mark Donegan, Precision Castparts's CEO, is a passionate manager who consistently pours the same energy into the business that he did before we purchased it. We are lucky to have him running things. I believe I was right in concluding that Precision Castparts would, over time, earn good returns on the net tangible assets deployed in its operations. I was wrong, however, in judging the average amount of future earnings and, consequently, wrong in my calculation of the proper price to pay for the business. Precision Castparts is far from my first error of that sort. But it's a big one."
Buffett admitted that he paid too much, but one could argue that he's being too hard on himself. The price paid was too high based on what we know today, but would that have been the case without the Covid-19 pandemic? The letter does not dwell on this matter, but I think it's something worth considering.
Limiting losses
This write-off is one of the most considerable single losses in Berkshire's history. Other large loss-making investments included ConocoPhillips (COP, Financial) (which cost about $2.5 billion), UK retailer Tesco, Dexter Shoe Co, the Waumbec Textile Company and purchasing Berkshire itself. This mistake cost as much as $200 billion in lost wealth, according to the billionaire investor.
The one common factor with all of these mistakes is the fact they were relatively small in the grand scheme of things. Excluding the purchase of Berkshire, which is always going to be difficult to quantify, Buffett has never incurred a loss of more than 1% on his portfolio.
While he has been able to limit his losses, he has also run his winners. For example, Berkshire started buying shares in Apple (AAPL, Financial) around the same time it bought Precision Castparts. Buffett spent around $36 billion to buy one billion shares in Apple (roughly the same amount invested in Precision Castparts). This stake is worth $118 billion today, and that's excluding $11 billion of realized capital gains.
These profits have more than compensated for the mistake of Precision Castparts. That's the most important takeaway of this case study. Mistakes will be made, but by focusing on limiting losses and maximizing profits, these mistakes are unlikely to become terminal.
Disclosure: The author owns no shares mentioned.
Read more here:
- 3 Things to Look Out for in Warren Buffett's Annual Letter
- Charlie Munger's Thoughts From the Daily Journal Annual Meeting
- Charlie Munger on Why He Still Holds Wells Fargo
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