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What can we learn from Warren Buffett’s biggest mistakes?
Peter Garnry
Chief Investment Strategist
Key points
- Challenges of scale: Warren Buffett's ability to outperform the market significantly diminished as his portfolio grew, with Berkshire Hathaway's returns since 2004 only marginally exceeding the S&P 500, demonstrating that even exceptional investment skills become less effective at large scales.
- Notable investment mistakes: Buffett's late-stage investment errors include poor timing with ConocoPhillips, overpaying for Precision Castparts, missing early investments in Amazon and Google, and misjudging IBM's potential. These mistakes highlight the risks of large, industry-specific bets and the importance of understanding disruptive technologies.
- Learning from mistakes: While learning from one's mistakes is challenging due to biases like confirmation bias, observing the errors of successful investors like Buffett can offer valuable insights, such as avoiding the tendency to extrapolate recent trends and recognizing disruptive innovations.
Everything gets more difficult with size
Warren Buffett is one of the greatest fundamental driven investors of all time with his claim to fame being is significant outperformance from the 1960s and way into the 1990s. As Buffett’s portfolio grew in size outperformance got more difficult. The chart below shows the total return since January 2004 between Berkshire Hathaway (Warren Buffett’s investment company) and S&P 500 Index. Over this 20-year period, Warren Buffett outperformed the US equity market by only 0.3%-points annualized delivering 10.6% annualized returns over this period. In other words, Berkshire Hathaway has become a proxy for S&P 500 and it shows that even great investment skills become obsolete at size.
Warren Buffett’s biggest mistakes
Despite Warren Buffett’s impressive track record he did make many mistakes. This should comfort any aspiring investor as even the best makes mistakes. We have highlighted below the five biggest mistakes that Warren Buffett did in his late stage as an investor.
ConocoPhillips
In 2008, just before oil prices were peaking, Warren Buffett invested a big part of the portfolio into US oil major ConocoPhillips betting on high oil prices to continue. As the world plunged into a catastrophic credit meltdown oil prices plummeted leading to large losses for Berkshire. Buffett admitted to “terrible timing” investing in ConocoPhillips and kept the position for years reducing his position to around $1bn as of June 30, 2014. The learnings are to be careful with companies in the resource sector and secondly think twice before investing in a stock that has experienced a dramatic momentum over multiple years.
Precision Castparts
In 2016, Warren Buffett acquired Precision Castparts which is a metal fabrication company with strong exposure to the aerospace sector. Berkshire paid $32.1bn at the time and was Warren Buffett’s largest acquisition at the time. In August 2020, as the Covid pandemic destroyed the aviation industry, Berkshire wrote off $9.8bn on this investment with Warren Buffett admitting that he “paid too much”. The learning is to avoid allocating a too large position in the portfolio to a single company that is also heavily exposed to a single industry.
Amazon
Warren Buffett is famous for investing in simple businesses that he can understand. He made his first investment in Walmart in 1998 and exited it in 2018 making a decent return. However, he also admitted that he regretted not seeing the potential earlier in Amazon as the e-commerce giant became one of the world's largest retailers while generating specular returns for its shareholders. One of the reasons for his hesitation was that he did not understand Amazon’s business. The learning is that sometimes you do not need to understand all the details of a company for it to be a great investment.
IBM
Warren Buffett’s IBM investment in 2011 came after years of saying he did not want to invest in technology stock because he did not understand them. His bet was that IBM played a role in the technology sector like auditing firms in the corporate world. Something that is necessary and stable. Warren Buffett was, in hindsight, clearly wrong on his assumptions and in 2017 he began trimming his investment and said IBM faced “big strong competitors”. It was not all bad, because the IBM investment pushed Warren Buffett into technology stocks which later led to a sizeable and very profitable position in Apple. The learning is to understand that the long-term technology winners are about disruption and scale economics, something IBM did not possess.
The last mistake was not an actual investment but rather a missed opportunity like Amazon. Warren Buffett admitted in 2019 that he made the wrong decision in not buying Google (known also as Alphabet). Maybe the complexities of technology were the culprit for Buffett. Google generated its vast majority of profits from advertising, but the company’s strength was not tied to advertising at all but instead its network effects in search engine and the low reinvestment rate in the business to sustain growth. The learning is to think deep about companies with superior characteristics and work backwards to understand the company is as strong as it is.
Do we actually learn from mistakes?
By observing the mistakes of the greatest investors like Warren Buffett we should in theory be able to learn faster than doing all the mistakes ourselves. A faster path to wisdom. This faster path to learning can only exist if we learn from our mistakes.
Previous studies have shown that entrepreneurs do not meaningfully increase their rate of success after failing in their first business. This statistic could indicate that learning is difficult. A study from Koestner et.al. (2017) shows, based on trading history of 19,487 individual investors, that underdiversification and the disposition effect* do not decline as investors gain experience. The authors, however, find that experience correlates with subsequently less portfolio turnover suggesting that traders to learn from overtrading because costs quickly eat into capital.
Our worst enemy when it comes to learning from past mistakes is ourselves and specifically what is called confirmation bias which means that we ignore or dismiss past mistakes, and only take into account information that confirms a given viewpoint.
Because of confirmation bias learning from other people’s mistakes can be a better choice and some of the takeaways from Warren Buffett’s mistakes are that one should avoid extrapolating the recent past into the future. It is also to not ignore major disruptive trends as e-commerce in his case.
* The disposition effect relates to the tendency of investors to sell assets that have increased in value, while keeping assets that have dropped in value.