I’m reading the letters to Berkshire Hathaway shareholders and in the 1989 letter, Warren Buffett brings a consolidation of the mistakes in the first 25 years of investing.

In the letters, Warren Buffett is very honest about his mistakes. He comments a lot about the mistakes made and about the damage caused by these decisions. I think this is one of his strengths, his honesty, and humility in saying that he makes mistakes, like all of us investors.

Below is a summary of Warren Buffett’s mistakes in the first 25 years of investing.

Warren Buffett’s mistake #1

According to Buffett, his first mistake was buying control of Berkshire, which, for those who don’t know, was a textile manufacturing company.

“Although I knew their business – textile manufacturing – was unpromising, I was drawn to buy because the price seemed cheap.”

Here Buffett cites that if you buy a stock priced low enough, you can usually make a decent profit even though the long-term performance might be terrible, but you need to be ready to offload the stock as soon as you see a rally in price. “I call this the “cigarette butt” approach to investing. A cigarette butt found on the street that has only one puff may still not offer much smoke, but “bargain shopping” will make that puff profitable”.

With this Buffett concludes that “it is far better to buy a wonderful company at a fair price than a fair company at a wonderful price”

Warren Buffett’s mistake #2

The second mistake Buffett reports is that he has had too many examples of creating bad companies with good management. He cites that “Good jockeys will do well on good horses, but not on broken-down nags.”

So, some companies failed not because of the management, but because they had bad economic characteristics. “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.”

Buffett adds, “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.”

Warren Buffett’s mistake #3

The third mistake cited by Buffett was trying to solve difficult business problems. “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”

Buffett adds: “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.”

Warren Buffett’s mistake #4

Buffet’s most surprising finding in his first 25 years of investing was that decent, smart managers don’t always make rational decisions.

“My most surprising discovery: the overwhelming importance in business of an unseen force that we might call ’the institutional imperative’. […] 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.”

To give some examples, he cites 4 of them: (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.”

He complements: “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.”

Warren Buffett’s mistake #5

The 5th mistake mentioned is related to the people to do business with. Avoid doing a good deal with a bad person.

“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.”

“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 are. We’ve never succeeded in making a good deal with a bad person.”

Warren Buffett’s mistake #6

He also cites that mistakes that he made are not always from commission but some were from omission.

“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.”

Warren Buffett’s mistake #7

In the last error listed in his letter, Buffett ends by saying that his conservatism may seem like a mistake, but it wasn’t.

“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.”

“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.”

I hope that learning from Warren Buffett’s mistakes can help us become better investors.

Happy investing!

Photo: Rick Wilking/Reuters