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Tesco PLC: Warren Buffett’s $444m Mistake

As I read through the annual letter to Berkshire Hathaway Inc (NYSE: BRK-A.US) (NYSE: BRK-B.US) shareholders, I noticed a section that you rarely see in most company presentations: an admission to a mistake!  There were no quotes of a ‘challenging market environment has lead to….’ or a ‘some contracts are now expected to be signed in the second half’ — just a simple admission to making a mistake.  In fact, a ‘big mistake’.  It is fair to say that when the greatest investor of our age holds his hands up to making a mistake, I listen and try to learn from it.

So, which company was he talking about?  Well, it comes as no surprise that he was talking about Tesco  (LSE: TSCO).

What Did He Write?

“Attentive readers will notice that Tesco, which last year appeared in the list of our largest common stock investments, is now absent. An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling. At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. 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. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.) “

Beware The Cockroach In Your Kitchen

He went on to say:

“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. (The company, we should mention, has hired new management, and we wish them well.) Our after-tax loss from this investment was $444 million, about 1/5 of 1% of Berkshire’s net worth.”

To put that into context:

“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.”

You Live and Learn.

I think, as a Berkshire Hathaway shareholder, I can forgive a 0.2% loss, given the track record of this compounding machine.  Still, $444 million is a sizeable amount — this could have been deployed elsewhere, or sat in the bank.  So, what can we learn from this admission?

Personally, I think that when a company announces that it is experiencing problems, it can be the tip of the iceberg.  There is a saying that profit warnings come in threes — as such, I tend to sell on the first one and watch from the sidelines.  Indeed, I sold my Tesco shares in June of 2013 and have not ventured back since.

As the legend pointed out, Tesco is under new management and the share price could progress from here. I suspect, however, they have a way to go in order to turn the ship around and holders could face a storm or two going forward.  I am still happy to watch and look for signs that things are improving across the board before making any purchase.

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Dave Sullivan owns shares in Berkshire Hathaway. The Motley Fool UK owns shares of Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.