According to Buffett, his biggest mistakes by far have been mistakes of omission. For example, in a talk founder Bill Gates in 1998 at the University of Washington Business School, Buffett explained:
"I've made all kinds of bad decisions that have cost us billions of dollars. They've been mistakes of omission rather than commission. I don't worry about not buying Microsoft, though, because I didn't understand that business. And I didn't understand Intel (INTC). But there are businesses that I did understand--Fannie Mae was one that was within my circle of competence. I made a decision to buy it, and I just didn't execute. We would've made many billions of dollars. But we didn't do it."
These mistakes don't show up in Berkshire's investment returns, but they are a genuine opportunity cost for the group and its investors.
Buffett's right-hand man and vice-chairman of Berkshire, Charlie Munger, elaborated on this topic at the group's 2001 annual shareholder meeting, saying, "The mistakes that have been most extreme in Berkshire's history are mistakes of omission. They don't show up in our figures. They show up in opportunity costs."
I tend to review past decisions, which is helpful in my improvement as an investor. As an investor, some of my biggest mistakes have been mistakes of omission as well.
For example, I have missed out on investing in companies that I understood, and were available at a good price. But I never quite pulled the trigger.
One example includes Microsoft (MSFT), which was available at a silly low valuation in 2009, 2011 and 2012 and 2013. I didn’t pull the trigger, despite spending my days in Microsoft Word and Microsoft Excel and Microsoft PowerPoint. And I still do. The fundamentals were solid, but the reason I didn’t invest was fear of change. I now think those fears were overblown, but didn’t think so then. Either way, I missed out on a 10 bagger.
Another example includes Intel (INTC), which was also available at a silly low valuation at thte time. I also didn’t pull the trigger due to fear of change. I didn’t understand it as much I wanted. In hindsight, missing out on Intel was fine, because while the company did work well initially, it has now not done as well. However, the issue is that my initial investment would have been limited to the amount I invested. Which would have limited my potential loss and exposure. But this thinking that prevented me from investing in Intel also prevented me from investing in Microsoft. Microsoft was a 10 bagger, and would have paid for 10 intels that went completely belly up.
With investing, the risk of loss is limited to the amount I invested in. But the upside is unlimited. What matters is how much you make when you are right, and how much you lose when you are wrong. That doesn’t mean to blundly take risks of course. But this example really shapes my view that I should have taken more risks, due to the assymetrical nature or risk/reward. Even if I was wrong 9 out of 10 times, which is way too conservative, one Microsoft would have still overcome the 9 Intels and resulted in an overall net profit. The important thing of course would have been to identify it and buy it in the first place.
Note that in the case of Microsoft I did end up pulling the trigger a few years ago. While the stock price was up and valuation was more expensive than a decade ago, it was still reasonable at the time. Just because a stock is at a 52 week high does not necessarily mean that the stock is overvalued.
I have also missed out on investing in companies within my investable universe, mostly because I had stringent entry criteria.
In addition, a stock selling at 25 times earnings and a "low" dividend yield of 1.80% that can grow those earnings and dividends can turn out to be "cheaper" than a stock selling at 14 times earnings and a dividend yield of 3.50% - 4%. Especially if the higher yielding stock fails to grow earnings per share.
I am basically comparing investing in Microsoft in 2017 versus investing in Pfizer or Verizon back then.
Investing is all about trade-offs. I often ask myself if I am being disciplined by having a strict entry criteria or whether I am being stubborn. An overview of my past decisions, coupled with studies of the old manuals of dividend achievers has shown me that the highest future yields on cost tended to come from companies with lower current yields. Which is why I eventually removed my entry criteria. But it took a lot of years to get there. I have also been relaxing my P/E ratio criteria as well.
Again, investing is all about trade-offs. On one hand you could say that I am being flexible in adapting to the real world environment. On the other hand however you could say that I am perhaps succumbing to Fear of Missing Out (FOMO). Just like everything else in life, it depends. It’s all a fine balance between two extremes that we need to walk on, day in and day out.
I mentioned above that I have relaxed my entry criteria. I do try to take into consideration the trade-off between dividend yield and dividend growth, and try to estimate the likelihood that future earnings and dividend growth can have a long runway. It’s a lot of guesswork, but guess what, a lot of investing is about guesstimates and probabilities, while estimating payoffs and frequencies of those payoffs as well.
The end result is trying to learn and improve.
For example, I learned a ton by studying other investors and investment strategies. A common denominator is casting a net on an investable universe, and then patiently holding tight for a long period of time. This patience allows for the best companies to compound uninterrupted, and rise to the top. All of this “patient inactivity” allows the power of compounding to do its heavy lifting. The most important rule is not to interrupt the power of compounding by doing something silly like selling too early or worse, not buying in the first place.
For example, I have been reviewing the list of Dividend Aristocrats for as long as I have been writing about Dividend Growth Investing on this blog.
I once compiled the returns of the 2011 Dividend Aristocrats List. I then traced to see the returns of each company over the next decade or so. I have done that for the 2013 list as well..
I owned a lot of the companies listed there. But I also had a few companies I never really invested in, for one reason or another. Mostly “reasons”.
I for example never invested in Cintas (CTAS). Cintas is the best performing dividend aristocrat ove the past decade. The stock was never really that expensive in the first place, although it is expensive today.
The irony is that the stock is not a company that is mentioned by other dividend investors. Nobody talked about it.
Many missed it.
Perhaps that’s because it had a small yield? However, the subsequent growth in earnings per share led to high dividend growth, which has translated into high yields on cost for those investors from say a decade or so ago. Much higher than the higher yields that never grew by much, which many seem to be obsessing over.
Either way, it just shows that one never really knows for sure. Perhaps casting a wider net of opportunities may be a better idea than being too restrictive. That’s because those tails may drive the distribution of statistical outcomes. Even if the expectation is that most things would more or less stay the same, it may be worth it to position yourself for surprises, just in case.
One of the most eye opening experiences has been studying index fund returns. Index funds never really take into consideration valuation. And they tend to weight portfolio companies based on market capitalization. And in general, they do not really make a lot of decisions. Yet, they do really well, relative to other investors, despite all of that. Their success is due to the fact that they do not force their opinions in general, but rather follow what’s working and stick with it. They basically cast a wide net over opportunities, giving them the chance of owning the next winner. Then they basically stick to owning that company, forever. A lot of those companies fail, but a few succeed. Those successes tend to really outshine the losers, and still result in the overall performance of 10%/year for the portfolio (at least historically). While some companies end up being overvalued and losing money, a few end up being correctly valued, even if they seem so at the time. Identifying those future winners, and sticking to those companies, through thick or thin, is very difficult. Yet, index funds succeed in that.
It's very hard to predict the future, and profit from it. So casting a wide net, and sticking to investments seems like a good process. My opinions, feelings, and attitude towards a company may actually turn out to be impediments to buying right and sitting tight. It’s something I often think about..
Today we discussed mistakes of ommission, which can be the costly mistake of not pulling the trigger on an opportunity. We also reiterated the importance of auditing your investing decisions, in order to improve as an investor over time. We have a lot of ignorance, and to succeed as investors we need to devise a plan and strategy to remove it bit by bit over time, in order to improve and succeed as investors.
I will conclude this post by the following quote from Charlie Munger, who was the right hand man of Warren Buffett.
“The main contribution of [buying See’s Candies] was ignorance removal. If we weren’t good at removing ignorance, we’d be nothing today. We were pretty damn stupid when we bought See’s – just a little less stupid enough to buy it. The best things about Berkshire is that we have removed a lot of ignorance. The nice thing is we still have a lot more ignorance left. Another trick is scrambling out of your mistakes, which is enormously useful. We have a sure to fail department store. A trading stamp business sure to fold and a textile mill. Out of that comes Berkshire. Think about how we would have done if we had a better start.” “See’s Candies was acquired at a premium over book (value) and it worked. Hochschild,Kohn, the department store chain (in Baltimore), was bought at a discount from book and liquidating value. It didn’t work. Those two things together helped shift our thinking to the idea of paying higher prices for better businesses.”