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The Real Lessons From Buffett’s Blighted Tesco PLC Trade

Photo: C41n. Cropped. Licence: https://creativecommons.org/licenses/by-sa/3.0/

Warren Buffett’s annual letter for Berkshire Hathaway is always a great read.

And this year’s – out just this week – is no different.

As usual, there’s a lot of nerdy talk for investing geeks like me about the vagaries of the insurance business and the travails of running a railway.

But this year he also included a folksy stroll down memory lane and the first 50 years of Berkshire under Buffett.

Reading all Buffett’s annual letters is a great education, incidentally.

You get to see his long-term plans laid out in the 1970s and 1980s, and then you see the fruits of the strategy in the stupendous returns achieved in the later years.

Indeed, Berkshire’s share price has grown at an average annual clip of 21.6% since Buffett took charge in 1965.

That makes for a total return of 1,826,163%!

If you know of a better investor to take advice from, I’d like to hear about them.

Tainted Tesco

But even Warren Buffett is not perfect – and his admission of his mistakes is another thing that has won over his legion of fans.

This time it was an investment gone wrong that’s close to many UK investors’ hearts that got the warts-and-all treatment.

You see, rather than brush his loss-making investment in Tesco (LSE: TSCO) under the carpet, Buffett flagged it up:

“Our cost for this investment was $2.3 billion, and the market value was a similar amount.

In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million.

My leisurely pace in making sales would prove expensive. […]

During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced.

In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.

We sold Tesco shares throughout the year and are now out of the position.

Our after-tax loss from this investment was $444 million.”

So what would you do if you were the world’s greatest investor and you lost nearly half a billion dollars?

Would you walk your shareholders through the error in detail?

Or would you ask the printers to blow up that 1,826,163% total return figure I mentioned in extra large type?

And perhaps have it printed in gold?

Am I better than Buffett?

You see, Buffett isn’t a worse investor because he admits when he’s wrong.

He’s a far better investor.

Admitting your failings and analysing your mistakes – instead of blaming the market or random events or share price manipulators or the phases of the moon – can help you avoid making similar slips in the future.

So the first lesson is to own your errors.

After all, it’s easy to get cocky.

For instance, I could point to this video I shot shortly after Buffett’s Tesco sale, where I said his dumping of the shares could mark a bottom, at least in the short term.

And I was right, give or take a few pennies.

In fact, in the five months since that video, Tesco’s share price has soared 33%!

So should I send my CV to Buffett, in case he wants a partner whose finger is still on the pulse?

Hardly.

One good call but no cigar

Firstly, I don’t think Buffett was wrong to sell Tesco, from his point of view.

Buffett doesn’t invest for short-term pops. He is looking for long-term compounding machines.

And I made exactly that point in a follow-up video, when critics said he was getting fearful in his old age.

The predictable fortunes of Tesco over the long term had soured, in Buffett’s eyes. So he sold.

As for the 33% price rise since my video, well, I can’t say I’m not pleased – but one good gainer over less than six months is not a very meaningful statistic.

Anyone can get a few calls right if they make enough of them.

What matters to your long-term returns (which over a typical working life would stretch almost as long as Buffett’s 50-year reign at Berkshire) is consistency, decade in and decade out.

Don’t bet the farm

This brings me to the last lessons that Buffett teaches us in this post-mortem of his blunder with Tesco.

Having ‘fessed up to losing his shareholders $444 million, Buffett explains the loss was just “1/5 of 1% of Berkshire’s net worth”.

That is, it dinged it by just 0.2%.

The third lesson, then, is clearly to diversify your portfolio.

If you’re in a position where a single poor investment seriously damages your long-term wealth, then you probably have too much in it.

Slow and steady wins the race!

Buffett continues:

“In the past 50 years, we have only once realized an investment loss that at the time of sale cost us 2% of our net worth.

Twice, we experienced 1% losses.

All three of these losses occurred in the 1974-1975 period, when we sold stocks that were very cheap in order to buy others we believed to be even cheaper.”

This is a staggering record considering Buffett’s five-decade-long tenure at Berkshire.

Again, it shows how diversification has buttressed his portfolio for generations.

But it also highlights Buffett’s long-term focus.

I am sure at least some of his other big investments fell below the price he paid for them, especially early on.

But Buffett didn’t sell in a panic.

And that’s the final lesson for success that Buffett has fashioned out of his minor disaster.

Know when to fold them, sure.

But don’t fold too easy, or too often.

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Both Owain and The Motley Fool own shares in Tesco.