Yesterday, billionaire investors Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) sat down with CNBC's Becky Quick in a segment titled, "Buffett & Munger: A Wealth of Wisdom."
The interview covered many topics. One section I thought was quite revealing was the duo's thoughts on their failed businesses. Quick had asked Buffett to tell the story of how he and Munger met and became friends. After telling the story, the duo moved on to discuss the first investments they made as partners.
Buffett and Munger on Blue Chip
One of their first deals was Blue Chip Stamps. Blue Chip issued stamps which customers could then redeem at retailers. The business model produced a high level of float, as it would hold the cash used to purchase the stamps on its balance sheet until they were redeemed. Some of these stamps were never redeemed, providing the company with free money. Buffett and Munger saw the opportunity to buy capital at a low cost, and they moved in with Rick Guerin.
In the CNBC interview, Buffett noted that the stamp business "disappeared," like many of the early businesses he had acquired. Following that comment, Munger added, "They didn't disappear. They failed."
Buffett agreed, but noted that Berkshire had survived because it had taken the cash out of these companies and used it to invest elsewhere, rather than chasing losses:
"The three base businesses all ended up disappearing. They, you know, they went outta business. They did, they no longer fit into the society, in a sense. And actually, the, the first, the very first deal that, that we joined in on was something called diversified retailing which was in Baltimore. We bought a department store there. And we had Sandy Gottesman had 10%, Charlie had 10%, and, and in his partnership, he had 10%, and I had 80% in our partnership, the three of us."
To cut a long story short, the trio sold the department store, and it "went outta business in 1983." The one key lesson Buffett and Munger learned from these early investments was "you don't wanna put more money into a business that's destined for failure."
This is a crucial lesson in business and life. Holding onto failing stocks and putting more money into bombing businesses is a quick way to lose a lot of cash. It took these two investors a while to learn this lesson, and the losses incurred during this period would be worth many billions of dollars today.
However, nothing is ever perfect in business. We'll all make mistakes at some point. The best thing one can do when one makes a mistake is learn from it. The worst thing one can do is compound the error by ignoring it or not learning from it, which may mean one repeats the mistake.
When Quick asked Buffett and Munger what they learned from their experience with the department store, Munger replied, "to leave quickly." Buffett added, "Yeah. And, and move the capital someplace else."
Munger summarized by saying, "One thing we've learned is, if it's clear that something is a mistake, is to fix it quickly. It doesn't get better while you wait."
The investors received about 95% of their money back from the retail venture, which was a good return considering the error. They then invested the money into Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) and used the cash to acquire stronger businesses in growth sectors.
It is possible to distill this entire experience down to a straightforward quote, which has been a mainstay of the stock market for decades: Let your winners run and cut your losers.
Recycling capital from a loser into winners is never a bad strategy, but hanging onto losers and riding an investment to failure is always going to end in tears.
This article first appeared on GuruFocus.