The Biggest Mistake Buffett Ever Made

Seabury Stanton was the CEO of a large textile manufacturer. And he lost his job over an eighth of a point…

Stanton met with one of the largest shareholders of his company and asked him a question… 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, 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 previously with the aforementioned large shareholder.

The large shareholder, was running a small investing partnership (what would be known today as a hedge fund). And he wasn’t pleased with Stanton’s move.

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 textile industry, he noticed something positive. As the company closed down manufacturing plants, it would sometimes use the proceeds to repurchase shares.

The stock was selling for around $7.50 per share when he began investing in the company. That 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, Berkshire Hathaway, and Stanton lost his job.

Why Buffett Is No Longer A ‘Value’ Investor

Few people know the origin story of Buffett’s relationship with Berkshire Hathaway. But you may be surprised to learn that Buffett claims his decision to buy Berkshire Hathaway was a $200 billion dollar blunder. And he said it was the “dumbest” stock he ever bought.

Why would Buffett say this? Well, it’s because he is no longer a “value” investor in a strict sense of the word.

Now this statement is likely to cause a stir among many investors, but hear 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. 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 in Berkshire Hathaway would have turned out to be exceptional. According to Buffett, had he simply accepted the $11.375 offer, his weighted annual return on the investment would have been about 40%. That’s 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 Buffett found a better way, thanks to his longtime business partner, who doesn’t get nearly the credit he deserves…

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.”

Closing Thoughts

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 my premium service 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 we own many names you’ve probably already heard about over at Top Stock Advisor. We don’t believe we need to find an obscure name with every single pick we make for our portfolio — although you will certainly find some of those, too.

More important is that we buy “wonderful businesses at fair prices.” It’s also easier said than done. But the end result is clear. Even right now, amid the Covid-19 pandemic, we have holdings that are far outpacing the market over the long-term. And they’re making us wealthier with each passing year.

If you want to learn more about these companies — and get your hands on their names and ticker symbols — then I invite you to learn more about my latest research here.