The story of Warren Buffett's biggest mistake - buying Berkshire Hathaway

A lesson in compounding

Dear Investors,

This is the story of Berkshire Hathaway’s humble beginnings.

It is a great illustration of the power of compounding - the secret to investing.

If you earn good rates of return over time, wealth is inevitable.

Sincerely, Raj

In 1955, two companies, Berkshire Fine Spinning and Hathaway Manufacturing agreed to merge their businesses. They had high hopes that the combination would be one of the strongest and most efficient organizations in the textiles industry. The merger was approved and Berkshire Hathaway was born.

However, in the nine years after the merger, Berkshire’s net worth nosedived from $51.4 million to $22.1 million. This was caused by operating losses, ill-advised dividends, stock repurchases and plant closures. These problems were not unusual as the textile industry was in decline.

In 1962, Warren Buffett began buying Berkshire stock. A few years later, in 1964, Berkshire’s General Manager, Seabury Stanton, made an oral offer to buy Buffett’s stake for $11.50 per share. Buffett agreed to the deal, but when he received the written offer, it was for $11.38 per share.

Buffett was incensed that Stanton had not kept his word, so instead of selling at the lower price, he decided to buy more stock and take control of the company. In 1965, Buffett took over. Seabury Stanton was removed and new management was installed.

At first Buffett maintained the textiles business, but it was doomed. So by 1967 Berkshire began expanding into insurance and other businesses. The reinvestment of earnings, coupled with the power of compounding worked its magic and Berkshire’s shareholders prospered. Berkshire struggled with the doomed textile operations for two decades and finally closed them in 1985.

The US Treasury (via tax collection) has benefitted tremendously from Berkshire. In the nine years following the 1955 merger of Berkshire and Hathaway, the company averaged tax payments of $100 per day. By 2021, Berkshire roughly paid $9 million daily to the US Treasury. In 2021, Berkshire paid $3.3 billion of the total $409 billion US Treasury corporate income tax receipts. Berkshire paid almost 1% of corporate income tax in the USA.

A Lesson in compounding

Berkshire currently has a net worth of $551 billion and a market value of $789 billion. From 1965 to 2021 Berkshire grew its market value by 20.1% per annum for 57 years. In comparison the S&P500 grew 10.5% per annum.

In monetary terms, $100 invested in Berkshire in 1965 would have been worth $3,600,000 by 2021. The same $100 invested in the S&P500 would be worth $30,000.

This perfectly illustrates the power of compounding. Relatively small differences in rates of compounding over time lead to massive differences in outcomes. To be fair a 10% difference is no small amount.

The same holds true for small amounts that reduce your investment rate of return. Think fees. One or two percent per annum may not seem like much, but the effect on your final outcome can be significant.

Modern Berkshire

Berkshire owns dozens of businesses which in turn own dozens more. Nevertheless modern Berkshire can be viewed as having four main parts:

  • Insurance operations – multiple insurance businesses that are fully owned and operated.

  • Apple – yes, the one that makes iPhones. In 2021, Berkshire owned 5.55% of Apple through the stock market.

  • BNSF – the massive railroad company which is indispensable to the US economy for moving goods.

  • Berkshire Hathaway Energy – the power utility, which leads in wind, solar and transmission through large parts of the USA.

Buffett’s biggest mistake

In 2010, Buffett claimed that purchasing Berkshire was the biggest investment mistake he had ever made. You see the insurance businesses, which powered Berkshire’s meteoric rise, were actually offered to Buffett personally. But he chose to acquire them through Berkshire, where he had a 37% stake. Had he bought them personally, he would have owned them 100%.

Buffett is currently worth about $120 billion and has given much of his Berkshire shares away to charity. However, in theory, if he owned 100% of Berkshire, he would have been worth $789 billion today. The wealthiest person in the world by far. The shareholders of Berkshire and charities owe him about $669 billion worth of thanks.

By the way, it was Warren’s birthday this week. He turned 93.

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