Thursday, November 21, 2019

Warren Buffett’s Eight Billion Dollar Mistake

Warren Buffett is arguably the best investor in the world. He has turned Berkshire Hathaway into one of the largest companies in the world over the past 50 - 60 years.

I have studied his partnership letters, annual shareholder reports, annual shareholder meeting notes, books and academic research about him and his statements for almost a decade. I believe that anyone can learn a ton about him. The most interesting fact is that he has been able to combine ideas from various investors and businessmen to further his investing record.

When I research anything about Warren Buffett, I start going on a journey in time, and start going in multiple different directions from there. There is a lot of information to grasp. There is a lot of information to be learned, and a lot of lessons for my investing. Once I start reading and going through footnotes, books or articles mentioned, I end up with a lot more to read than I bargained for. But I always learn something new to share with you.

For example, back in the 1960s, Buffett found out about Walt Disney Company (DIS). (Source)

"We bought 5% of the Walt Disney Company in 1966. It cost us $4 million dollars. $80 million bucks was the valuation of the whole thing. 300 and some acres in Anaheim. The Pirate’s ride had just been put in. It cost $17 million bucks. The whole company was selling for $80 million. Mary Poppins had just come out. Mary Poppins made about $30 million that year, and seven years later you’re going to show it to kids the same age. It’s like having an oil well where all the oil seeps back in. Now the [numbers today are] probably different, but in 1966 they had 220 pictures of one sort or another. They wrote them all down to zero – there were no residual values placed on the value of any Disney picture up through the ‘60s. So [you got all of this] for $80 million bucks, and you got Walt Disney to work for you. It was incredible. You didn’t have to be a genius to know that the Walt Disney company was worth more than $80 million. $17 million for the Pirate’s Ride. It’s unbelievable. But there it was. And the reason was, in 1966 people said, “Well, Mary Poppins is terrific this year, but they’re not going to have another Mary Poppins next year, so the earnings will be down.” I don’t care if the earnings are down like that. You know you’ve still got Mary Poppins to throw out in seven more years, assuming kids squawk a little. I mean there’s no better system than to have something where, essentially, you get a new crop every seven years and you get to charge more each time. 

$80 million dollars [sigh]. I went out to see Walt Disney (he’d never heard of me; I was 35 years old). We sat down and he told me the whole plan for the company – he couldn’t have been a nicer guy. It was a joke. If he’d privately gone to some huge venture capitalist, or some major American corporation, if he’d been a private company, and said “I want you to buy into this. This is a deal,” they would have bought in based on a valuation of $300 or $400 million dollars. The very fact that it was just sitting there in the market every day convinced [people that $80 million was an appropriate valuation]. Essentially, they ignored it because it was so familiar. But that happens periodically on Wall Street."

He managed to buy 5% of Disney common stock for about $4 million dollars. The next year, he sold the stock for a 50% gain in 1967. That turned his initial investment into $6 million. I wanted to test how much money he would have if he had held on to the $6 million worth of Disney stock, and hadn’t sold.

This is a 20 year view for Disney from an old Moody's Handbook of Common Stocks from 1980:

I recently obtained access to a database of historical equity prices and financial information. It included information about Disney. While the database had already adjusted share prices for the numerous stock splits, including stock dividends, it had not adjusted for the impact of these splits on cash dividends. Therefore, I could not calculate total returns.

But I saw that the ending split adjusted price was at $0.11701/share in 1967. The stock is at around $150/share today.

This means that a $6 million investment in Disney at the end of 1967 would have turned into $7.7 billion today.

Source: Global Financial Data

This assumes that he didn’t reinvest any dividends along the way for 52 years.

Obviously, this would have increased his returns substantially. The stock pays a semi-annual dividend of 88 cents/share, which turns out to $1.76/share.

By my calculations, this investment would be generating close to $90 million in annual dividend income. This is over 22 times the amount of his initial capital at stake.

I believe that Disney paid a total of $15/share over the past 50 years in dividends. I did not want to go through the reinvestment of these dividends over 50+ years, so I did not calculate reinvestments.
This is why dividends are a return on investment but also a return of investment.

It just shows that if you have a good quality company like Disney, and you purchase it and hold it for the long-term, you can do very well for yourself. The power of long-term compounding is evident when you hold on to great businesses which tend to increase intrinsic value over time. As Charlie Munger has said it, the best thing to do once you find a great business is to buy it, and then to sit on your chair. You are not going to get that many ideas to buy and hold, just as much as you are not going to get that many opportunities to flip stocks for a quick gain every year or two as well. This is a lesson that Buffett actually shared in one of his investment partnership letters and one of his shareholder letters.

Investors who frequently buy and sell stocks may make money, but they have to work hard to compound their asset base. This means that they have to sell shares and pay taxes. When you buy and hold, a large portion of unrealized capital gains never get taxes for as long as you do not sell. This is a deferred type of float from the US Government. You get more money working for you.

The lesson for me is that selling is usually a mistake. The lesson is that buy and hold works – but only for those patient enough to buy and hold for decades. The other lesson is to focus on companies with strong brands and strong competitive advantages, which have enduring qualities. The other lesson is that just because a super-investor sold, that doesn’t mean you should sell. Buffett has famously disposed shares of Disney in the 1967, American Express in 1966 and McDonald’s in 1998.

Not all of his sales were poor however. When he disposed of his shares in Freddie Mac in 2001, which was one of the rare moments where selling was timely and worth it. Some of his investments were not as good, but he didn’t sell. A prime example for that is the Berkshire Hathaway mill. Per Buffett’s calculations, if he had stuck with an insurance company from the beginning, and he had never heard about Berkshire, he would have been tens of billions of dollars richer.

Hindsight is always 20/20 of course. But I believe that we can learn a lot from these examples.

In my investing, I have noticed that companies I sell tend to do very well afterwards. The companies that I buy with the proceeds do not do as well. Plus, I tend to pay taxes on the investment gains I have generated, which means I have had less money working for me. The goal of the capitalist is to not interrupt the virtuous nature of the power of compounding. By frequently trading stocks, that’s exactly what is being done. This is an error that needs to be addressed. For the majority of you, the goal is to buy and hold, and not actively trade. This of course assumes diversified portfolios.
You should not sell, because most of your gains in your investing lifetime will come from just a handful of securities. Most investors tend to sell companies for a quick gain, but then tend to hold on to their losses. They should keep their shares, and not sell.

Of course, Buffett is a super-investor. He is not like you and me.

The same $6 million, invested in Berkshire Hathaway at the end of 1967 would have bought 315,789 shares. The price was $19/share at the end of 1967.

These shares today are worth over $104 billion.

Source: Global Financial Data

Investing is fun, isn’t it?

That being said, I still believe in buy and hold, inactivity, and letting my portfolio do the heavy lifting for me. I still believe in focusing on quality companies with solid competitive advantages, not overpaying for these quality companies, and keeping investment costs to the bone.

If you find a great company, you should do nothing once you buy it. Even if it takes a few years to show profits, the successful investor needs to show some patience. Otherwise, they would spend their investing lifetime buying high and selling low, thus compounding their mistakes and never growing their investment portfolios and dividend incomes.

Relevant Articles:

Disney (DIS) Dividend Stock Analysis
How Ordinary Investors Can Generate Float Like Buffett
How to improve your investing over time

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