Showing posts with label unforced errors. Show all posts
Showing posts with label unforced errors. Show all posts

Thursday 8 April 2010

Buffett (1989): We've never succeeded in making a good deal with a bad person.

Warren Buffett mentioned about his investment mistakes of the preceding 25 years in his 1989 letter to shareholders. Let us round off that list of what he feels were his key investment mistakes.

"My most surprising discovery: the overwhelming importance in business of an unseen force that we might call 'the institutional imperative'. In business school, I was given no hint of the imperative's existence and I did not intuitively understand it when I entered the business world. I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn't so. Instead, rationality frequently wilts when the institutional imperative comes into play."

How often have we seen merger between two companies not producing the desired outcome as was projected at the time of the merger? Or, how often have we seen management retain excess cash under the rationale that it will be used for future acquisitions? Further still, a lot of companies do things just because their peers are doing it even though it might bring no tangible benefits to them. The master has labeled these so called propensities to do things just for the sake of doing them 'the institutional imperatives' and has termed them as one of his most surprising discoveries. Further, he advises investors to steer clear of such companies and instead focus on companies, which appear alert to the problem of 'institutional imperative'.

Given the master's great predisposition towards choosing business owners with the highest levels of integrity and honesty, it comes as no surprise that one of his investment mistake concerns the quality of the management. This is what he has to say on the issue.

"After some other mistakes, I learned to go into business only with people whom I like, trust, and admire. As I noted before, this policy in itself will not ensure success: A second-class textile or department store company won't prosper simply because its managers are men that you would be pleased to see your daughter marry. However, an owner - or investor - can accomplish wonders if he manages to associate himself with such people in businesses that possess decent economic characteristics. Conversely, we do not wish to join with managers who lack admirable qualities, no matter how attractive the prospects of their business. We've never succeeded in making a good deal with a bad person."

Next on the list of investment mistakes is a confession that makes us realise that even the master is human and is prone to slip up occasionally. But what makes him a truly outstanding investor is the fact that he has had relatively fewer mistakes of commission rather than omission. In other words, while he may have let go of a couple of very attractive investments, he's hardly ever made an investment that cost him huge amounts of money.

This is what he has to say: "Some of my worst mistakes were not publicly visible. These were stock and business purchases whose virtues I understood and yet didn't make. It's no sin to miss a great opportunity outside one's area of competence. But I have passed on a couple of really big purchases that were served up to me on a platter and that I was fully capable of understanding. For Berkshire's shareholders, myself included, the cost of this thumb-sucking has been huge."

The master rounds off the list with a masterpiece of a comment. It gives us an insight into his almost inhuman like risk aversion qualities and goes us to show that he will hardly ever make an investment unless he is 100% sure of the outcome. It comes out brilliantly in this, his last comment on his investment mistakes of the past twenty-five years: "Our consistently conservative financial policies may appear to have been a mistake, but in my view were not. In retrospect, it is clear that significantly higher, though still conventional, leverage ratios at Berkshire would have produced considerably better returns on equity than the 23.8% we have actually averaged. Even in 1965, perhaps we could have judged there to be a 99% probability that higher leverage would lead to nothing but good. Correspondingly, we might have seen only a 1% chance that some shock factor, external or internal, would cause a conventional debt ratio to produce a result falling somewhere between temporary anguish and default.


We wouldn't have liked those 99:1 odds - and never will. A small chance of distress or disgrace cannot, in our view, be offset by a large chance of extra returns. If your actions are sensible, you are certain to get good results; in most such cases, leverage just moves things along faster. Charlie and I have never been in a big hurry: We enjoy the process far more than the proceeds - though we have learned to live with those also."

Monday 4 May 2009

Buffett admits investment mistakes but shareholders keep the faith

Buffett admits investment mistakes but shareholders keep the faith

The legendary stockpicker dubbed the Sage of Omaha still wowing the crowds despite 35% drop in Berkshire Hathaway share price

Andrew Clark in Omaha, Nebraska
guardian.co.uk, Sunday 3 May 2009 19.47

It is usually a festival of financial self-congratulation in the US heartland. But a sombre tone descended on Warren Buffett's annual investor meeting as the legendary stockpicker was obliged to defend the worst year of his career.

Facing a record crowd of 35,000 shareholders in his Berkshire Hathaway business empire, who had come from as far afield as Australia and South Africa, Buffett admitted this weekend that he had failed to "cover himself in glory" since the global financial crisis began.

"It's been an extraordinary year," he said. "I'm not sure you'll see this again in your lifetime."

Held in Buffett's home city of Omaha, the quirky annual gathering of Berkshire's shareholders has become known as Woodstock for capitalists. Investors queued from 4am yesterday to snatch prime seats in the Qwest arena. A light-hearted video depicted the billionaire being demoted to a mattress salesman in one of his Nebraska Furniture Mart stores as punishment for the loss of Berkshire's treasured triple-A credit rating.

For six hours, Buffett, 78, and his lifelong business partner, Charlie Munger, 85, fielded queries chosen by a panel of journalists about their investment approach. "There's always a lot of things wrong with the world," Buffett told investors. "Unfortunately, it's the only world we've got so we have to deal with it."

Losing Berkshire's blue-chip credit rating, Buffett admitted, was "disappointing", causing the firm to "lose some bragging rights around the world" in terms of the rock-solid reliability of the insurance policies it sells. It was part of a string of setbacks for Berkshire, which has seen its shares slump by 35% since the start of 2008.

The book value of the company's assets, which include a stake in Tesco and ownership of Northern Electric, fell by 9.6% in only his second negative year since 1965. Investments ranging from Fruit of the Loom underwear to American Express credit cards and NetJets corporate aircraft caught the thick edge of the recession. First-quarter operating profits fell from $1.9bn (£1.3bn) to $1.7bn.

Shareholders, by and large, are still unstinting in their faith. Charles Hostetler, an insurance agent from Kansas, compared Buffett to a St Louis Cardinals baseball star of the 1960s, Bob Gibson. "You've got a great pitcher like Bob Gibson. He had one bad year in a 20-year career and 18, 19 good years," said Hostetler. "You wouldn't give up on him after one bad year, now would you?"

He added: "It wasn't a good year for Berkshire, but it wasn't a good year for America either."

But Wall Street critics say Buffett's Midas touch has deserted him through a series of unforced errors. A punt on two Irish banks went spectacularly awry as their stocks plunged by 89% and he made a costly investment in the energy firm ConocoPhillips just as the oil price peaked last summer.

Many have queried a decision by Buffett to plunge into derivatives – once scorned by the billionaire as "financial weapons of mass destruction". At the end of 2008, Berkshire had contracts with a notional long-term value of $67bn betting on the long-term performance of stocks and bonds.

Buffett has also found himself on the back foot over Berkshire's 20% stake in the credit-rating agency Moody's.

Quizzed about this, he said: "There was almost total belief throughout the country that house prices not only wouldn't fall significantly but would keep rising. The ratings agencies built that into their models."

The cult-like status of Buffett endures, despite these mishaps. In the Qwest arena's exhibition hall, shareholders snapped up packs of playing cards bearing images of Buffett and a popular T-shirt for children reads: "Warren Buffett is building my future."

Some took a more sceptical view. David Newton, a South African who came from Johannesburg for the meeting, welcomed the tougher examination of Buffett: "Last time I was here was completely a prayer meeting. If somebody had asked Warren if they should fly to the moon and he'd said yes, they'd have gone straight off and done it."

Still sprightly in his seventies and adept at playing the ukulele, Buffett has balked at publicly naming a successor, saying he sees no value in having a "crown prince" lurking around. He has, however, revealed that he has four potential proteges in mind. In a worrying sign, Buffett disclosed that none of these apprentice investment managers had beaten a 37% drop in the S&P 500 index last year. "You would not say they covered themselves with glory," he said. "But I didn't cover myself in glory either, so I'm pretty tolerant of that."


Bad news for papers

A former paperboy, Warren Buffett is a fan of newspapers but he offered a gloomy perspective on prospects for publishers struggling with falling readerships and dwindling advertising. "For most newspapers in the United States, we wouldn't buy them at any price," said Buffett, who has a stake in the Washington Post and owns the Buffalo News in New York.

Buffett said circulations were being eroded at an accelerating pace, hitting commercial revenue: "They were essential to advertisers only as long as they were essential to readers, and that is changing … I don't see anything on the horizon that causes that erosion to end." Although a technophobe, he feels newspapers, with the possibility of "unending losses", offer little attraction for investors.

http://www.guardian.co.uk/business/2009/may/03/warren-buffett-shareholder-meeting