I didn’t know anything about the stock when I bought it…I just knew it was my father Howard’s favorite stock
Warren Buffett
Investing is a risky game, and even the legendary investor Warren Buffett is not immune to making mistakes. However, what sets him apart is his ability to acknowledge his errors and learn from them. He shares his experiences and lessons learned at Berkshire Hathaway’s annual shareholder meetings, believing that others can benefit from his mistakes.
In his 30 years of investment experience, two types of mistakes were identified that investors cannot afford to make: those that they cannot afford to bear and those that they do not learn from.
In this article, we will focus on Warren Buffett’s investment failures throughout his long investment career and the lessons he learned from them. Making mistakes in investing is inevitable, but what matters is having the introspection to learn from them. If you deny your mistakes and blame others or external factors, you are bound to repeat them.
As Charlie Munger, Buffett’s longtime business partner, once said, “You’re not going to make good decisions in life if you haven’t suffered a lot.” Making mistakes is part of the journey, but learning from them is how you become a better investor.
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Investing Lessons from Warren Buffett at 12 Years Old
“Don’t Focus on Buying Costs and Don’t Chase Small Profits”
Warren Buffett started selling chewing gum at the age of six and used the profits to buy second-hand golf balls to sell at age 10. By the age of 12, he had accumulated $120. His sister, Doris, became his partner, and Buffett used $114.75 to buy three preferred stocks of City Services. “I didn’t know anything about the stock when I bought it,” Buffett said. “I just knew it was my father Howard’s favorite stock.”
In June of that year, the market was in a downturn, and City Services’ preferred stock price fell from $38.25 to $27. Doris reminded Buffett every day on the way to school that his stock was falling, and he felt enormous pressure. When the stock rebounded, he sold it for $40, earning $5 for himself and Doris. However, City Services’ stock price quickly rose to $202.
Buffett learned three lessons during this period, which he considers one of the most important periods of his life.
The first lesson is not to focus too much on buying costs. It’s easy to get caught up in the excitement of a bullish stock, but it’s essential to take a step back and consider the long-term potential of an investment. It’s also crucial to remember that investing is a long-term game, and profits may not be realized immediately.
The second lesson is not to chase small profits without thinking. It’s tempting to sell a stock as soon as it reaches a certain profit threshold, but this approach can limit your potential earnings. Instead, investors should focus on the underlying fundamentals of a company and invest for the long-term. If he had been more patient, he could have made $492. He regretted this mistake deeply because he worked for five years to accumulate $120 to buy this stock. To make up for the “lost” profit, it would take many years. He will always, always, always remember this mistake.
The third lesson is about investing other people’s money. If he makes an investment mistake, someone else may suffer from anxiety and distress because of him. Therefore, he doesn’t want to be responsible for anyone’s money unless he’s very confident he will succeed.
Everyone has bought into a bullish stock at some point, but not everyone can hold onto it, “How to hold onto a bullish stock” is a question that we often face.
Warren Buffett
In investing, many investors are eager to lock in profits of 20-30% and hope to sell as soon as possible. However, smart investors pursue “one and done” because making several small profits in investing cannot compare to one big profit in terms of wealth accumulation. The three lessons learned by 12-year-old Buffett are still worth investors to comprehend today.
In the world of investing, there are no guarantees, and the market is unpredictable. However, by learning from successful investors like Warren Buffett, investors can develop a better approach to investing.
“Cheap” Stocks May Not Be Cheap at All: the Importance of Analyzing the True Value of “Cheap” Stocks
Although I knew at the time that the company’s main business – the textile industry – had a dim future, I was still tempted by its seemingly low stock price and couldn’t resist buying it
Warren Buffet on Berkshire Hathaway stock
Warren Buffett’s first purchase of Berkshire Hathaway stock was on December 12, 1962, for 2,000 shares at $7.5 per share plus a broker commission of $20. By 1965, Buffett had increased his stake in Berkshire Hathaway by 49% and was elected as the chairman of the board. Berkshire Hathaway was a struggling textile company with no hope, but it was cheap. Twenty-one years later, Buffett liquidated Berkshire Hathaway’s textile business.
Buffett described his investment in Berkshire Hathaway as follows: “Although I knew at the time that the company’s main business – the textile industry – had a dim future, I was still tempted by its seemingly low stock price and couldn’t resist buying it.” In the early days of his investment career, this type of stock investment brought him reasonable returns until the emergence of Berkshire Hathaway in 1965, which made him realize that this investment strategy was not ideal.
Buffett later said in his letter to shareholders that the above investment method is foolish unless you are a professional liquidator. First of all, the initially “cheap” price may not be cheap at all in the end. A struggling company will have another problem shortly after solving one, just like if you have cockroaches in your kitchen, it’s impossible to have only one.
Secondly, any initial advantage you get will soon be eroded by the company’s low returns. For example, if you buy a company for $8 million, which you can quickly sell or liquidate for $10 million and execute immediately, then you can achieve high returns. However, if this company is disposed of for $10 million ten years later, even if there are a few points of dividends each year during this period, the investment will still be disappointing. Time is a friend of excellent companies and an enemy of mediocre ones.
Buffett said that this experience taught him a lesson: a good rider can only perform well on a good horse, and not on a bad horse. Both Berkshire Hathaway’s textile business and Hochschild Kohn Department Store had capable and loyal management teams. The same management team will achieve good results in companies with excellent economic characteristics. But if they run in quicksand, there will be no progress.
A good rider can only perform well on a good horse, and not on a bad horse
Warren Buffett
Another related lesson Buffett explained was that we have not learned how to solve the problems of difficult companies, but instead, we focus on avoiding them. We focus on finding those that can cross a 1-foot hurdle, rather than those that have the ability to cross a 7-foot hurdle. Profit will be more abundant by simply adhering to those easily understandable and obvious goals than getting out of trouble.
Buffett also said, “You may think that this principle is obviously plain, but I had to learn it the hard way, actually, I had to learn it many times. Shortly after acquiring Berkshire Hathaway, Buffett also acquired a department store – Hochschild Kohn Company. Fortunately, three years later, he disposed of the company at the buying price.
Munger described this investment as “we bought a second-rate department store at a third-rate price.” Munger sharply said, “Buying Hochschild Kohn was like a story of a person buying a yacht. There are two happy days, one is the day you buy it, and the other is the day you sell it.”
In investing, cheap may be due to the capital market mispricing, which represents value for money. For such cheap and high-quality companies, heavy bets can be placed. However, it may also be an investment trap.
In conclusion, a cheap valuation is only the beginning of an investment, not the end. For example, some Hong Kong property stocks have a low valuation of 4 or even 2 times P/E, but this profit is only a book profit, not real cash flow. The highly leveraged operating model of some property stocks makes their valuation distorted. The “cheap” in investing may not be truly cheap, so it is essential to analyze the profit quality behind the cheapness.
The Painful Lesson: Competition is Harmful to Wealth
In 1989, Warren Buffett made what he calls his “Today’s Headline Error Prize” gold medal mistake by buying $358 million worth of preferred stock in American Airlines, which represented a 9.25% share. Between 1990 and 1994, American Airlines lost a total of $2.4 billion, which wiped out all of the company’s common stock’s book value. When American Airlines suspended dividends in 1994, Berkshire Hathaway reduced its investment in American Airlines preferred stock by 75% due to the uncertain situation.
Buffett’s lesson learned was that when a company sells ordinary commodity-type products (or services), it cannot be smarter than the dumbest competitor. Buffett said he liked and respected the CEO of the company at the time, Ed Cronin, but his analysis of American Airlines was both superficial and flawed. He became enamored with the company’s long-term profitable operating history and trusted the protection provided by the senior securities (preferred stock).
The critical area that Buffett overlooked was that American Airlines’ revenue would gradually be affected by the fierce market competition resulting from the end of price controls, while its cost structure remained a continuation of the regulated era. If these unchecked costs were a harbinger of disaster, then following the airline’s past record might also have been.
Competition is harmful to wealth
Peter Lynch
Peter Lynch, another legendary investor, also said that companies selling ordinary commodities should have a warning label on their stocks that says “competition is harmful to wealth.” In an ordinary commodity-type business without a moat, a company must reduce costs to a competitive level, or it will perish.
However, dramatically, American Airlines began to recover in 1997, and Buffett eventually received the unpaid dividends on his preferred stock, and the company’s common stock price rose from $4 per share to $73. After all the suffering, Buffett finally made a fortune.
Unfortunately, Buffett made the same mistake again in 2016 when he invested in the four major “airline” companies in the United States and sold them in April 2020, forcing him to learn the lesson he had learned before once again.
Missed Opportunities: The Most Torturous Lesson in Investing
In the words of Warren Buffett, the most torturous mistakes are the ones that we know we should have made, but didn’t. These mistakes refer to missed opportunities to invest in companies or stocks that we know hold great value. While it’s not a crime to miss opportunities outside of our circle of competence, Buffett himself has missed out on several once-in-a-lifetime opportunities that were well within his understanding.
Charlie Munger, Buffett’s partner and friend, also recognizes the cost of missed opportunities. He once said, “The biggest mistakes in Berkshire Hathaway’s history have been errors of omission. We saw it, but didn’t act on it. They’re huge mistakes – we’ve lost billions as a result. We are trying to improve our process, but we have not eliminated this problem altogether.”
Munger believes that these mistakes fall into two categories: doing nothing (what Buffett calls “sucking your thumb”) and buying too little of a stock that you know you should have purchased more of.
Buffett gave an example of this in 1989 when Berkshire Hathaway invested $600 million in preferred shares of Gillette, which later converted to 48 million common shares (adjusted for stock splits). An alternative approach was for Berkshire Hathaway to directly purchase 60 million common shares. At the time, the common shares were trading around $10.50, with at least a 5% discount considering the significant restrictions attached to large private placements. Two years later, Buffett realized that if he had purchased the common shares instead of the preferred shares, Berkshire Hathaway would have had an extra $625 million in 1995, after deducting an additional $70 million in dividends. He mocked himself, saying, “I’m not that smart.”
You’re not going to make good decisions in life if you haven’t suffered a lot
Charlie Munger
Missed opportunities can be costly, especially for Berkshire Hathaway shareholders, including Buffett himself. It’s important to recognize the value of opportunities within our circle of competence and take action when necessary.