For the first two decades of his career, Warren Buffett managed several investment partnerships for outside investors, mainly friends and family who entrusted their money to the young investor.

Buffett’s investment strategy in this early part of his career was based on what he learnt under Benjamin Graham, who has since become known as the Godfather of value investing. He perfected a strategy of buying stocks trading at a significant discount to the underlying value of their assets and holding, generating returns in excess of 20% per annum for himself and his partners. One of these investments was a textile company called Berkshire Hathaway.

Buffett and Berkshire

Buffett was originally attracted to Berkshire Hathaway because it was cheap. The market capitalisation was below the net asset value of the business. “I bought the first shares of Berkshire in 1962 and it was a northern textile business destined to become extinct eventually… It was a statistically cheap stock and a terrible business,” Buffett told viewers in HBO’s documentary, Becoming Warren Buffett.

Berkshire was a business in terminal decline. The company could not compete with competitors who could manufacture the same product at a lower cost, so it was closing mills and returning capital. “Berkshire Hathaway was closing mills, and as they closed mills it would free up some capital, and then they would re-purchase shares,” explains Warren Buffett explains in the HBO documentary. “So I bought some stock with the idea that there would be another tender offer at some point, and we would sell the stock at a modest profit.”

Eventually, Buffett and Berkshire’s management agreed that the company would buy out the partnerships’ holdings for $11.50 per share in 1965. Considering he first bought shares in Berkshire Hathaway back in 1962 for a price of $7.50, this was an acceptable return.

However, when the tender came out “it was at $11.375, an eighth of a point cheaper,” which irritated Buffett.

A big mistake

Rather than take the cash and walk away, Buffett made what he has called the biggest mistake of his career. “I just started buying more stock,” he explains. “In 1965, I bought enough so we controlled the company, and we changed the management.”

This irrational reaction from one of the world’s most rational investors changed the course of Buffett’s career forever. He now owned a struggling textile enterprise, with no experience in the business and no obvious way out.

The Oracle of Omaha has since called this his biggest mistake estimating it cost him more than $200 billion in lost profits as Berkshire continue to struggle along for the next 20 years, consuming his capital and time, but producing little in compensation.

Rather than try to keep the business going, Buffett decided the best course of action was to take the cash produced by Berkshire and reinvest these funds into other, more profitable industries, such as insurance. The National Indemnity Company was the first in a long line of outstanding acquisitions Berkshire made in the following years.

These business deals have transformed the enterprise from a struggling textile concern into the world’s largest insurance group and one of the world’s largest conglomerates.

Disclosure: The author owns shares in Berkshire Hathaway.

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