Warren Buffett (Trades, Portfolio) has made several severe investment mistakes over the past decade. He has admitted as much himself, saying in various interviews that Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) investments in IBM (IBM, Financial), Kraft Heinz (KHC, Financial) and U.K.-based retailer Tesco (LSE:TSCO, Financial) were all, to varying degrees, mistakes.
I think these mistakes tell us a lot about Buffett's investment strategy and the way he evaluates companies before making a move.
Buffett's mistake analysis
We know Buffett only makes an investment when he believes the risk of a permanent capital impairment is zero, and in each one of these cases he has been correct. He has not suffered a permanent capital loss in any of these investment. In fact, as I have calculated before, with IBM, it is possible he made a slim profit including dividends (the jury is still out when it comes to Kraft Heinz).
By focusing on the downside, Buffett has avoided making any serious mistakes that have put Berkshire's future in jeopardy. This does not just apply to recent errors, it applies to the conglomerate's entire history.
Even though he has made numerous mistakes throughout his career, none of them ever put Berkshire in jeopardy. While some have cost the conglomerate billions of dollars, the group has remained liquid, stable and with more than enough money to continue doing what it does best -- making money for shareholders. Although he hasn't sold the position in Kraft Heinz yet, I think the same lessons apply. Buffett has admitted he made a mistake, but the error is unlikely to be terminal.
Buffett realized very early on in life how important the power of compounding is for wealth over the long term. He also realized how important it is to avoid permanent capital impairment, as it can have a significant impact on the future. Indeed, compounding not only increases your profits over time, but it also increases losses.
Strategically cutting losses early may be emotionally painful, but it ensures the impact won't have too much of a detrimental effect on your portfolio over the long term. Buffett has known this for many years, though it didn't stop him from making the big mistake of taking control of Berkshire when the group's original management failed to make good on their promises. (Buffett has since admitted that the death of his father, which occurred around the time of this uncharacteristic takeover, might have had some impact on his decision.)
Three conclusions
I think investors can learn much more from mistakes than they can success stories, and that's why I am reviewing Buffett's three biggest errors. We can draw three main takeaways from his actions over the past decade.
First, it is essential to run winners and cut losers, even though, as mentioned above, it may be emotionally painful. It is vital to do so if you want to protect your capital and succeed over the long term. Losses can compound in the same way profits can.
Second, on no occasion has there been even a moderate risk that Buffett and Berkshire's investors will lose all of their money. IBM, Tesco and Kraft Heinz may have all turned out to be bad investments, but they are still profitable multibillion-dollar businesses that are unlikely to vanish into obscurity anytime soon.
Third, it is never too late to change your mind. Buffett once said you don't have to make money back "the same way you lost it," acknowledging that everyone will make bad investments. It is what you do with those investments that defines whether or not you are a good or a bad investor.
Disclosure: The author owns shares of Berkshire Hathaway.
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