The Biggest Mistake Buffett Ever Made
Seabury Stanton, CEO of a large textile manufacturer, lost his job over an eighth of a point... but the man who ousted him lost billions of dollars in the process.
Stanton met with one of the largest shareholders of his company and asked him at what price he would be willing to sell his shares back to the company. The shareholder quickly responded with a price of $11.50 per share, to which Stanton agreed.
In May of 1964, shortly after the meeting with the aforementioned shareholder, Stanton sent a letter to shareholders offering to buy 225,000 shares of its stock for $11.375 per share... an eighth of a point less than what he had agreed to.
The large shareholder, who was running a small investing partnership (what would be known today as a hedge fund) wasn't pleased with Stanton's price.
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Less than two years prior, this shareholder had done his due diligence on the company. Although he knew there were some major headwinds in the overall industry, he noticed that as the company closed down manufacturing plants it would sometimes use the proceeds to repurchase shares.
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The stock was selling for around $7.50 per share when he began investing in the company, which was a major discount from the per-share working capital of $10.25 and book value of $20.20. This was value investing at its finest.
As he wrote in his annual shareholder letter:
"Buying the stock at that price was like picking up a discarded cigar butt that had one puff remaining in it. Though the stub might be ugly and soggy, the puff would be free."
Instead of accepting the tender offer of $11.375 per share and booking a 50% gain after which he could have moved on to other investment opportunities, he aggressively began buying more shares of the failing textile company.
By April 1965, his investment firm, Buffett Partnership Ltd., had increased its stake from around 7% to nearly 40%. Warren Buffett then took control of the textile manufacturing company, called Berkshire Hathaway, and Stanton lost his job.
Buffett claims that his decision to buy Berkshire Hathaway was a $200 billion dollar blunder and the "dumbest" stock he ever bought.
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Why Buffett Is No Longer A 'Value' Investor
Now this statement is likely to cause a stir among many investors, but here me out...
As a disciple of Benjamin Graham -- the father of value investing -- Buffett was taught how to identify a company that was trading at a significant discount to its net assets, and whether it was a worthy investment. He dubbed this investment style as his cigar-butt strategy, and this framework for value investing served him quite well in his early years.
For example, had his ego not gotten the better of him, his investment of Berkshire Hathaway would have turned out to be exceptional. According to his newsletter, had he simply accepted the $11.375 offer, his weighted annual return on the investment would have been about 40%, an incredible return in less than two years.
Remember, Buffett knew that the textile business had its problems, but he was picking up shares of the company for a fraction of what they were worth. This strategy of buying mediocre companies trading at bargain prices worked well in the short-term.
But this cigar-butt strategy wasn't the way forward for someone who wanted to build a large and enduring firm. Don't get me wrong, I'm not saying value investing doesn't work -- it very much does. It's just that thanks to Buffett's longtime business partner they found a better way...
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Buffett's business partner, Charlie Munger, may not be as famous as the Oracle of Omaha, but he's played an instrumental role in Berkshire's success over the years.
It was Munger who taught Buffett that while buying decent companies at cheap prices was good, it was better to "buy wonderful businesses at fair prices" and hold on to them "forever."
I hope that statement is familiar to longtime readers of my premium newsletter, Top Stock Advisor. That's because it's the foundation on which the publication was built: finding excellent companies at good prices that can compound their earnings and reward shareholders for many years.
This sort of strategy may sound obvious, but far too few investors actually practice it. They get too caught up in chasing risky triple-digit gains that they forget to take the safe, "no-brainer" gains sitting right in front of them. That's why I created a special report about what I think are the absolute best investments to own for the long term. I call them "Forever Stocks." If you want to learn more about these companies -- and get your hands on their names and ticker symbols -- then I invite you to follow this link.
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