Warren Buffett - “Buying Berkshire was a mistake”. Lessons from this “bargain” purchase: Part 1

Key takeaways at the end

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My first mistake, of course, was in buying control of Berkshire. Though I knew its business – textile manufacturing – to be unpromising, I was enticed to buy because the price looked cheap. Stock purchases of that kind had proved reasonably rewarding in my early years, though by the time Berkshire came along in 1965 I was becoming aware that the strategy was not ideal.

If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. 

I call this the "cigar butt" approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the "bargain purchase" will make that puff all profit.

Unless you are a liquidator, that kind of approach to buying businesses is foolish. 

First, the original "bargain" price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces – never is there just one cockroach in the kitchen. 

Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. [...] Time is the friend of the wonderful business, the enemy of the mediocre.

I could give you other personal examples of "bargain-purchase" folly but I'm sure you get the picture: It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Charlie understood this early; I was a slow learner. But now, when buying companies or common stocks, we look for first-class businesses accompanied by first-class managements.

That leads right into a related lesson: Good jockeys will do well on good horses, but not on broken-down nags. The same managers employed in a business with good economic characteristics would have achieved fine records. But they were never going to make any progress while running in quicksand. 

I've said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact. 

A further related lesson: Easy does it. After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them. To the extent we have been successful, it is because we concentrated on identifying one-foot hurdles that we could step over rather than because we acquired any ability to clear seven-footers.

The finding may seem unfair, but in both business and investments it is usually far more profitable to simply stick with the easy and obvious than it is to resolve the difficult.

1989 Shareholder Letter

* Bold emphasis added

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Key concepts and takeaways:

• Low price ≠ bargain purchase: Based on my experience, there is typically a good set of reasons for a stock trading at a low price. This is not to say that markets are fully efficient and prices always reflect the value you get. However, you need to always remember that there are other very sophisticated investors looking at the same stock. You need to develop what Howard Marks calls second-level thinking.

• Compounding vs. quick returns: You need to generate investment ideas and find businesses that will benefit from compounding over long periods of time. Your time is limited, do not waste it on finding multiple “cigar buts” with one puff left. Focus on few, but great companies. Do not feel like you have to come up with many and / or complicated investment ideas. Degree of difficulty does not count.