How a mistake in the textile business led the Oracle of Omaha to become one of the richest people in history
Warren Buffett has worked his way to becoming the world’s greatest investor through hard work and self-control. His ability to ignore wider market trends and invest against the herd is legendary and so is his ability to ignore all but the most lucrative investment opportunities.
Like all investors, Buffett has made mistakes over his career. And he believes the most significant mistake was the one occasion where he let his ego get the better of him, and he became emotionally involved in the opportunity.
Buffett estimates this one mistake cost him $100 billion, an enormous sum and one that would have completely changed his career.
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In an interview with CNBC in October 2010, Buffett explained that this $200 billion mistake was, in fact, Berkshire Hathaway. Why was this his worst trade of all time? It all comes down to capital allocation and compounding.
Buffett's Textile Business Mistake
Buffett originally acquired an interest in Berkshire Hathaway because it was a traditional net net opportunity. The company’s textile business had been floundering for years, but it was still producing some cash and was trading below book value. After acquiring a significant stake in the business, Buffett visited management, Mr Seabury Stanton, who told the upcoming Omaha investor that the company had just sold some textile mills and was looking to return capital to shareholders. Buffett offered to tender his stock at $11.50, a price agreed on by Stanton.
However, Stanton went back on his word, as Buffett describes:
“Here it is: a tender offer from Berkshire Hathaway— that's from1964. And if you look carefully, you'll see the price is … 11 and three-eighths. He chiseled me for an eighth. And if that letter had come through with 11 and a half, I would have tendered my stock. But this made me mad. So I went out and started buying the stock, and I bought control of the company, and fired Mr. Stanton. And we went on from there.”
Even though Buffett had got his way and payback he acknowledges that he “committed a major amount of money to a terrible business.” For 20 years Buffett tried to make Berkshire Hathaway work, 20 years of putting capital into a dying business. If this capital had been reallocated to good businesses, such as insurance Buffett estimates Berkshire Hathaway could have become twice the size it is today ($200 billion on October 2010 figures).
At the heart of this story there is a good lesson about the difference between buying bad businesses that are cheap and good businesses at a reasonable price. As Buffett notes in the interview:
“Because I started out with Ben Graham in 1950 or so. And his whole idea was buying things that were cheap. You don't want to buy things that are cheap. You want to buy things that are good. It's much better to buy something that's good at a fair price, than something that is cheap at a bargain price. And I wasn't— I didn't start out that way. I— I was taught a different system. But— but if I didn't learn from Berkshire Hathaway, I'll never learn.”
Even fantastic managers can’t turn around bad businesses. Another lesson Buffett learned too late:
“Well, it took me 20 years to give up on the textile business. I had a wonderful guy running it after— after Seabury Stanton— a fellow named Ken Chase ran it. And he was terrific. Honest and able, hardworking. And h ecouldn't make it go. But we just kept working at it, trying— we bought another textile company called Waumbec Mills in Manchester, New Hampshire. Another mistake. If you're gonna be brilliant with a lousy business, why not be brilliant with a good business?”
This has formed the basis of Buffett’s investing career ever since. Even though it took him 20 years to work his way out of Berkshire’s legacy business, he notes that it was clear almost straight away the business wasn’t salvageable but kept thinking “I’m not going to give up on this”.
Even though this scenario proved costly for Buffett, it is what it is and who knows how his career would have turned out if it were not for this early mistake. Luckily, he turned his fortunes around quickly with the acquisition of insurance companies to fit alongside Berkshire with the cash the textile business was throwing off.