Sixty years ago, Warren Buffett bought control of Berkshire Hathaway. He’s highlighted that mistake on and off ever since.
He did so once again in this year’s annual letter, which came out over the weekend. Handling mistakes was the first of several lessons in his letter.
Quick to Fix Mistakes
Sometimes I’ve made mistakes in assessing the future economics of a business I’ve purchased for Berkshire – each a case of capital allocation gone wrong. That happens with both judgments about marketable equities – we view these as partial ownership of businesses – and the 100% acquisitions of companies…
A decent batting average in personnel decisions is all that can be hoped for. The cardinal sin is delaying the correction of mistakes or what Charlie Munger called “thumb-sucking.” Problems, he would tell me, cannot be wished away. They require action, however uncomfortable that may be.
No investor is perfect. Not even Buffett. Mistakes are part of the game. It’s a recurring theme throughout his annual letter going back decades.
Part of risk management is ensuring that when mistakes do hit, the cost is manageable. Because often times it’s not the mistake that gets you but the unwillingness to take a loss or, worse, the inaction in fixing it.
“Cut your losses” is an investing rules of thumb not because you should automatically sell losers but because mistakes that fester are difficult to overcome. The bigger the mistake, the bigger the hole to climb out of just to get even before you’re back to growing your money.
Winners More Than Make Up for Mistakes
I’ve also had many pleasant surprises in both the potential of the business as well as the ability and fidelity of the manager. And our experience is that a single winning decision can make a breathtaking difference over time. (Think GEICO as a business decision, Ajit Jain as a managerial decision and my luck in finding Charlie Munger as a one-of-a-kind partner, personal advisor and steadfast friend.) Mistakes fade away; winners can forever blossom.
The advantage of a diversified portfolio is knowing that imperfect decisions can still lead to success. You can be wrong. You can make mistakes.
You can also get lucky. Some things may turn out better than expected. You can still earn a solid return because the winners more than make up for it in the long run.
Buffett used Berkshire as example of this later in the letter based on the companies under its umbrella:
These 189 subsidiaries have similarities to marketable common stocks but are far from identical. The collection is worth many hundreds of billions and includes a few rare gems, many good-but-far-from-fabulous businesses and some laggards that have been disappointments. We own nothing that is a major drag, but we have a number that I should not have purchased.
If you look at the distribution of returns over the years from the companies inside Berkshire or even an index fund, you’ll find some companies did poorly, some broke even, some were good, some great, and a handful were phenomenal.
The good, great, and phenomenal companies more than make up for the rest and drove returns.
Play the Long-Term Game
Over time, we think it highly likely that gains will prevail – why else would we buy these securities? – though the year-by-year numbers will swing wildly and unpredictably. Our horizon for such commitments is almost always far longer than a single year. In many, our thinking involves decades. These long-termers are the purchases that sometimes make the cash register ring like church bells.
Imagine a world where Buffett only played the short-term game and reacted every time his stocks swung up or down. If emotion ruled those decisions, he’d sell after every drop, buy after every rise. Where would Berkshire be then? It probably would have failed long ago.
That type of short-term game often overreacts to big price swings. It’s driven by emotions much more than studied reasoning. It’s plagued by recurring mistakes. It’s not a game many people win.
The long-term game is different. It accepts that markets are unpredictable and volatility is a feature of the system. It follows a plan of attack because volatility plays on emotions, which is detrimental to success. It’s built on the simple premise the compounding works best over time.
The long-term game is one of the few remaining edges for investors.
Hedging Inflation
Berkshire will never prefer ownership of cash-equivalent assets over the ownership of good businesses, whether controlled or only partially owned.
Paper money can see its value evaporate if fiscal folly prevails. In some countries, this reckless practice has become habitual, and, in our country’s short history, the U.S. has come close to the edge. Fixed-coupon bonds provide no protection against runaway currency.
Businesses, as well as individuals with desired talents, however, will usually find a way to cope with monetary instability as long as their goods or services are desired by the country’s citizenry.
Inflation is a hidden cost on your money that eats away at your purchasing power over time. That cost is not constant year to year and can be exacerbated by the poor decisions of government.
Buffett offers two solutions to this problem that is in our control. The first, invest in businesses. Companies have the ability to raise prices over time to offset some, if not most, of the costs incurred by inflation. A company’s growth, on average, takes care of the rest…and then some. Historically, stocks have more than made up for the loss of purchasing power over time.
His second solution, increase your income. Inflation not only impacts your ability to spend, it also hits your ability to save too. The best to way overcome the rising cost of living, is to make yourself more desirable to employers. Improve and hone your skillset to the point that companies can’t live without you.
Source: 2024 Berkshire Shareholder Letter
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