One of the most interesting investment case studies in Warren Buffett (Trades, Portfolio)'s long career was his purchase through Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) of preferred stock in USAir in 1989.
The conglomerate acquired $358 million worth of the airline's preferred stock that year. Soon after the deal was disclosed, the airline announced it would lose money in 1989 and 1990. The common stock dropped by 50% after the profit warning.
Losses grow
Two factors impacted the airline's performance in the late 1980s and early 1990s.
Spiking fuel costs significantly increased costs for the group, a fare war gutted its revenue and wage inflation was another headwind. In 1990 alone, the corporation lost a staggering $454 million. It registered tens of millions of dollars in losses in 1989. Buffett's cash infusion was nowhere near enough to cover the bleeding.
By the mid-1990s, it looked as if the investment was not going to work out for Berkshire. At the 1994 annual meeting of investors, the Oracle of Omaha informed his audience that it was an investment he should not have made.
However, he believed the company still had scope to cut costs and improve its operating performance before it was a complete write-off.
At this point, Berkshire had written down the value of the investment substantially. It seems Buffett might have believed that it was worth nothing.
Nevertheless, the guru understood that while the investment might have turned sour, there were plenty of other opportunities out there. I think this event produced one of his best quotes of all time.
Buffett's sage advice
When Buffett was asked at the 1995 annual meeting what he was planning to do with the remainder of the investment, he responded:
"It is true that a very important principle in investing is you don’t have to make it back the way you lost it. And in fact, it’s usually a mistake to make — try and make it back the way that you lost it."
Buffet said that investors do not have to double down on unsuccessful holdings. Usually, the better option is to find another opportunity, one that has brighter prospects. Doubling down on a failed position can lead to disaster.
His right-hand man, Charlie Munger (Trades, Portfolio), reiterated this sentiment, saying:
"That’s the reason so many people are ruined by gambling. They get behind and then they feel they have to get it back the way they lost it. It’s a deep part of the human nature."
Buffett added that it is important to remember the stock does not know who bought it. It does not "give a damn," if investors are making money or losing money.
In times of uncertainty, it is important to keep this principle in mind. One of the great things about being an investor, especially an individual investor, is the fact we don't have to stick with the companies we own. We can just move on if a business is not working out, unlike the business owners who have to stick with the sinking ship.
Turning your back on a company that is not working out and moving on to something else can be psychologically difficult, but this is the approach the best investors have to adopt.
If an investment opportunity is not working out, there will be others. Moving on is usually the best course of action. The opportunity cost of not doing so could be high as it will increase the longer one holds on to a position.
Ultimately, Buffett's USAir investment did work out for Berkshire. The corporation got its money back as well as a few dividend payments. It could have made more money elsewhere, but it was not a total disaster.
Also check out:
