Many people overlook their mistakes and only look at their strengths. The problem is doing this invariably leads to more mistakes (repeating the same mistakes over and over again). Many people look at Warren Buffett, the most successful investor in history, and only look at what he does right. In Mr. Buffett’s infinite wisdom, he actually does the opposite, he analyzes his mistakes (so he can learn and not repeat them).

Every year tens of thousands of people flock to attend Mr. Buffett’s annual shareholder meeting. The event is covered by the press, academia and everything in between. Mr Buffett’s flagship company is Berkshire Hathaway, and he has been at the helm for 49 years. On his 25th anniversary he published this letter to shareholders which outlined the mistakes of his first 25 years. Next year will mark his 50th anniversary at the helm,  and hopefully  he will update and share the lessons he’s learned from the first 50 years of his legendary career.

1. Cigar Butt: Don’t buy stocks just because the price is cheap. Instead, buy quality companies and look for growth.

2. Time is the friend of the wonderful business, the enemy of the mediocre. Remember that profits are a function of time. Be patient with your winners.

3. Good jockeys will do well on good horses, but not on broken-down nags. Same is true for good management. Numbers don’t lie. If the numbers are poor, it will be very difficult for even the best managers to show up and save the day.

4. Avoid business problems, don’t solve them. When buying a business look for the problems. If they are not easily fixed, invest your money somewhere else.

5. Beware of irrational behavior or what Mr. Buffett calls, the unseen force that we might call “the institutional imperative.” People will likely stick the course (to protect their pride/egos) than admit defeat and be open to a new course of action.

6. Go into business only with people whom you like, trust, and admire.

From the 1989 Berkshire Hathaway 1989 letter to shareholders:

Mistakes of the First Twenty-five Years (A Condensed Version)

To quote Robert Benchley, “Having a dog teaches a boy

fidelity, perseverance, and to turn around three times before

lying down.” Such are the shortcomings of experience.

Nevertheless, it’s a good idea to review past mistakes before

committing new ones. So let’s take a quick look at the last 25

years.

o 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. For example, if you

buy a business for $8 million that can be sold or liquidated for

$10 million and promptly take either course, you can realize a

high return. But the investment will disappoint if the business

is sold for $10 million in ten years and in the interim has

annually earned and distributed only a few percent on cost. Time

is the friend of the wonderful business, the enemy of the

mediocre.

You might think this principle is obvious, but I had to

learn it the hard way – in fact, I had to learn it several times

over. Shortly after purchasing Berkshire, I acquired a Baltimore

department store, Hochschild Kohn, buying through a company

called Diversified Retailing that later merged with Berkshire. I

bought at a substantial discount from book value, the people were

first-class, and the deal included some extras – unrecorded real

estate values and a significant LIFO inventory cushion. How could

I miss? So-o-o – three years later I was lucky to sell the

business for about what I had paid. After ending our corporate

marriage to Hochschild Kohn, I had memories like those of the

husband in the country song, “My Wife Ran Away With My Best

Friend and I Still Miss Him a Lot.”

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.

o That leads right into a related lesson: Good jockeys will

do well on good horses, but not on broken-down nags. Both

Berkshire’s textile business and Hochschild, Kohn had able and

honest people running them. 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. I just wish I hadn’t been so energetic in

creating examples. My behavior has matched that admitted by Mae

West: “I was Snow White, but I drifted.”

o 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. On

occasion, tough problems must be tackled as was the case when we

started our Sunday paper in Buffalo. In other instances, a great

investment opportunity occurs when a marvelous business

encounters a one-time huge, but solvable, problem as was the case

many years back at both American Express and GEICO. Overall,

however, we’ve done better by avoiding dragons than by slaying

them.

o My most surprising discovery: the overwhelming importance in

business of an unseen force that we might call “the institutional

imperative.” In business school, I was given no hint of the

imperative’s existence and I did not intuitively understand it

when I entered the business world. I thought then that decent,

intelligent, and experienced managers would automatically make

rational business decisions. But I learned over time that isn’t

so. Instead, rationality frequently wilts when the institutional

imperative comes into play.

For example: (1) As if governed by Newton’s First Law of

Motion, an institution will resist any change in its current

direction; (2) Just as work expands to fill available time,

corporate projects or acquisitions will materialize to soak up

available funds; (3) Any business craving of the leader, however

foolish, will be quickly supported by detailed rate-of-return and

strategic studies prepared by his troops; and (4) The behavior of

peer companies, whether they are expanding, acquiring, setting

executive compensation or whatever, will be mindlessly imitated.

Institutional dynamics, not venality or stupidity, set

businesses on these courses, which are too often misguided. After

making some expensive mistakes because I ignored the power of the

imperative, I have tried to organize and manage Berkshire in ways

that minimize its influence. Furthermore, Charlie and I have

attempted to concentrate our investments in companies that appear

alert to the problem.

o After some other mistakes, I learned to go into business

only with people whom I like, trust, and admire. As I noted

before, this policy of itself will not ensure success: A second-

class textile or department-store company won’t prosper simply

because its managers are men that you would be pleased to see

your daughter marry. However, an owner – or investor – can

accomplish wonders if he manages to associate himself with such

people in businesses that possess decent economic

characteristics. Conversely, we do not wish to join with managers

who lack admirable qualities, no matter how attractive the

prospects of their business. We’ve never succeeded in making a

good deal with a bad person.

o Some of my worst mistakes were not publicly visible. These

were stock and business purchases whose virtues I understood and

yet didn’t make. It’s no sin to miss a great opportunity outside

one’s area of competence. But I have passed on a couple of really

big purchases that were served up to me on a platter and that I

was fully capable of understanding. For Berkshire’s shareholders,

myself included, the cost of this thumb-sucking has been huge.

o Our consistently-conservative financial policies may appear

to have been a mistake, but in my view were not. In retrospect,

it is clear that significantly higher, though still conventional,

leverage ratios at Berkshire would have produced considerably

better returns on equity than the 23.8% we have actually

averaged. Even in 1965, perhaps we could have judged there to be

a 99% probability that higher leverage would lead to nothing but

good. Correspondingly, we might have seen only a 1% chance that

some shock factor, external or internal, would cause a

conventional debt ratio to produce a result falling somewhere

between temporary anguish and default.

We wouldn’t have liked those 99:1 odds – and never will. A

small chance of distress or disgrace cannot, in our view, be

offset by a large chance of extra returns. If your actions are

sensible, you are certain to get good results; in most such

cases, leverage just moves things along faster. Charlie and I

have never been in a big hurry: We enjoy the process far more

than the proceeds – though we have learned to live with those

also.

* * * * * * * * * * * *

We hope in another 25 years to report on the mistakes of the

first 50. If we are around in 2015 to do that, you can count on

this section occupying many more pages than it does here.

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