Buffett’s thoughts on some business disasters
The skills required to manage a business and invest are relatively similar. Business owners and managers have to juggle many different skill sets. From financial management to crisis resolution and human resources, owners and operators must learn how to manage their operations effectively.
One can take these skills and use them when investing. For example, I think it is extremely helpful, perhaps essential, that every investor should have a basic grasp of accounting at the bare minimum. They should also understand what makes a business tick, its strengths and weaknesses, management skills, etc.
Most successful business managers and operators will already have these skills, making it easier to find successful investments. Crisis management is one of those skills that is often overlooked, but it is just as important for individual investors as it is for business operatives.
Investors need to know and understand when to cut their losses and move on from a particular business. Most of the time it’s quite challenging to tell when a company is heading in the wrong direction. With that being the case, investors need to act quickly when the cracks start to show.
There are plenty of examples in the business world of managers who did not act quickly enough when problems started to emerge in their businesses. Unlike managers, investors have the freedom to sell when things take a decisive turn for the worse – if they can identify the problems in time.
When the cracks start to show
At the 2017 Berkshire Hathaway annual meeting, Warren Buffett (Trades, Portfolio) highlighted two case studies of investments where things started to go wrong in the underlying business. The two examples he picked were Salomon Brothers and Wells Fargo (NYSE:WFC).
Buffett had to step in to rescue Saloman Brothers in the early 90s when it became apparent that a rogue trader at the investment bank was causing some severe problems in the U.S. Treasury market. Buffett had provided the business with a significant loan to fend off a corporate raider, and he took an active stance to defend his investment, ultimately becoming Chairman.
At the 2017 meeting, Buffett described that the investment bank’s problems became worse as soon as the c-suite was alerted to the rogue trading activity but failed to do anything about it. He noted, “the main problem was they didn’t act when they learned about it. It was bad enough having a bad system, but they didn’t act.”
The Oracle of Omaha explained that Wells made the same mistakes. Both had inadequate systems in place to uncover bad behavior and failed to do anything about bad behavior when they discovered it.
Buffett went on to add that avoiding mistakes in business is impossible. Every company will make some mistakes at some point, but it’s how the company deals with these problems that really distinguishes the good businesses from the bad.
The same is true of investors. Every investor will make mistakes, but it’s how one deals with these mistakes that really matters. For example, one could follow Saloman and Wells’ examples – do nothing and keep plugging away at the same bad strategy. One could also learn from the mistakes and develop a strategy to move away from these errors.
A record of mistakes
The first stage of this process is to take a step back and establish what went wrong and why it went wrong. Only when one has this information can one make a plan to try and move away from past errors and avoid things that have gone wrong.
This is where keeping a trading diary and making notes on potential investments is invaluable. One can only analyze what went wrong with an investment if one has the information used to purchase the investment in the first place.
These details can form the first part of the analysis. It’s certainly not an easy process, but by evaluating and what has gone right and what has gone wrong in the past, we can work to improve our investment processes bit by bit.
Disclosure: The author owns no share mentioned.
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About the author:
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.
Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.
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