U.S. Markets open in 3 hrs 37 mins

Warren Buffett's Biggest-Ever Loss: 20% of His Net Wealth

At the young age of 21, Warren Buffett (Trades, Portfolio) made what was to become his greatest investment mistake, in terms of net wealth, ever.

That year he invested 20% of his net worth in an unprofitable investment, a Sinclair service station in his hometown of Omaha, Nebraska. He lost all of the $2,000 invested out of his total net wealth of $10,000.


No competitive advantage

Buffett's decision to buy the gas station in 1951, however, was not a total waste of money. He learned a very valuable lesson from the experience.

Specifically, the experience that a company without a competitive advantage isn't a particularly good investment as competitors can quickly undercut the business on price.

The young investor bought the stake in the gas station with a friend. The business struggled from the beginning because it was opposite a much larger Texaco station, which, according to Glen Arnold's book, "The Deals of Warren Buffett, Volume 1: The First $100M," consistently outsold Buffett's business.

To try and help improve profit margins, Buffett even worked weekends at the counter. Speaking about the idea at a later date, he said that the Texaco station was "very well established and very well-liked." It also had customer loyalty and a repeat clientele. "Nothing we could do to change that," he added.

This learning experience cost the young investor $2,000, or 20% of his net worth, at the time.

The opportunity cost of this money has continued to grow ever since. Speaking to a group of business school students in 1998, the Oracle of Omaha declared:


"Back when I had $10,000, I put $2,000 of it into a Sinclair Service Station, which I lost, so the opportunity cost on that money is about $6 billion right now -- fairly big mistakes. It makes me feel good when my Berkshire goes down, because the cost of my Sinclair Station goes down, too."



Every investor will make a significant mistake at some point in their careers. Buffett believes these missteps are just part of the process, however, and we should try and learn as much as possible from them.

Also, he has said it is never wise to spend hours dwelling on past mistakes. Investors should recognize their errors, learn from them and move on. Spending time worrying about the mistake will only compound the error and make it worse over time.

Building on the lesson

Buffett's gas station mistake, for example, put the foundation in place for the rest of his investment career. He was able to learn the powers of competitive advantage and customer loyalty, which helped significantly when analyzing investments later in life. Companies like American Express (NYSE:AXP) and Coca-Cola (NYSE:KO), which are some of the most important investments in the Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) portfolio today, have a tremendous amount of customer loyalty and robust competitive advantages.

Buffett didn't let his loss hold him back in 1951; he went right back out and started looking for the next good idea.

The next deal he found was Rockwood and Co., a cheap, unloved cookie company with a large inventory of cocoa beans.

Rockwood tried to sell itself to Benjamin Graham's investment company, Graham-Newman, but the price was too high. It found another investor willing to take a significant stake, who then proceeded to sell off the inventory at a profit. The investor also offered shareholders a payoff in the form of cocoa beans if they sold their shares back to the company.

The young Buffett worked out that the company was worth significantly more than the cocoa bean offer and went on to buy 222 shares. From an initial price of $15 per share, the stock eventually hit $100, earning Buffett a profit of $13,000, quickly covering his gas station losses and then some.

Disclosure: The author owns shares of Berkshire Hathaway.

Read more here:



Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.

This article first appeared on GuruFocus.