3 Misconceptions about Warren Buffett

Warren Buffett is so often talked about in the press, on the internet and in conversations among the investing public that truth and falsehood blur, and a picture of the man is distorted like an image in a funhouse mirror. The man is not infallible, and he is also amenable to change when it benefits his company, Berkshire Hathaway (BRK-A, BRK-B).

Although Buffett is one of the greatest investors of the last century, he makes mistakes like any other human being. Perhaps the occasional blunders stand out because there are so few on his resume.

Buying US Airways preferred stock in 1989 is the mistake most often cited by critics. Buffett knew the airline business had no protective moat, and later stated the industry was a death trap where investors had lost massive money since the inception of air travel. Airlines consume enormous amounts of capital, yet Buffett thought he was protected by a 9.25% dividend yield on his $350 million preferred stock purchase. He discovered, however, that US Airways' 12 cent per seat mile cost could not compete against cost-cutting airlines such as Southwest's 8 cent per seat mile cost. During this escapade, Buffett endured a loss of dividend income for two years, and reports say he either broke even or lost a small amount of money on the deal.

Another forgettable investment was the 1993 acquisition of the Dexter Shoe Company using 1.6% of Berkshire Hathaway stock. On the surface, this seemed to meet many of Buffett's criteria for a sound investment, but it did not measure up to the concept of a "moat" that kept competitors at a disadvantage. Dexter ultimately imploded, and the company is out of business as of today. In 2008, Buffett pointed to Dexter as "the worst deal I've ever made." There are other mistakes including a billion dollar loss involving Energy Future Holdings bonds, but the big wins swamp Buffett's losing bets.

Buffet began as a student of Benjamin Graham, who taught an emphasis on buying cheap stocks relative to net assets and book value, holding them until their intrinsic values were reflected in market price, and then selling the stocks before moving on to other stocks with similar characteristics. The influence of Buffett's partner, Charlie Munger, tossed this mindset to the side and Berkshire Hathaway's portfolio has never been the same.

Munger's investment philosophy is to buy great businesses with formidable franchises resistant to competitive pressure. He convinced Buffett the Graham approach would not work if Berkshire wanted to ascend to a higher level, and Buffett bought the concept. The result is that the Berkshire portfolio is concentrated in long-term holdings of stocks such as Coca-Cola, Wells Fargo and American Express. These are blue-chip stocks with financial characteristics that have no affinity to a Benjamin Graham approach in terms of company financial measurements.

Buffett also agreed with the Munger concept of a concentrated portfolio that emphasizes fewer stocks than a classic value investor would feel comfortable with; moreover, the holding period of Munger's franchise stocks is "forever" according to Buffett. Finally, Munger also prodded Buffett into swallowing the big elephants such as Burlington Northern and making them part of Berkshire Hathaway's portfolio of wholly owned subsidiaries. In many ways, Charlie Munger's influence on Warren Buffett is substantial and probably unappreciated by many investors.

Buffett talks often about investing in businesses he understands. The technology sector did not meet this criterion for him, and it also failed to provide his required margin of safety and protective moat against competitors. Yet, if you look at the Berkshire Hathaway portfolio, there is a presence of technology stocks. It is true the allocation is small relative to total portfolio size in most cases, but it does exist and includes the company's second to-top holding.

Consider Apple, for example. As of Buffett's 2018 letter to shareholders in late February, Apple was the second largest holding in the portfolio with over 166 million shares, with a market value of over $28 billion. Computer services comprise a large percentage of Apple business, and that is likely the rationale used to purchase such a large stake. This compares to Buffett's longtime holding of Coca-Cola at 9.4% of the entire company with a market value of over $18 billion.

Warren Buffett is the man behind the curtain, and the avuncular, cherry-coke swilling, Ben Graham acolyte portrayed in the press is often far off target. Buffett has evolved in his investment approach, thanks in large part to Charlie Munger, and he should continue to find ways to burnish his reputation in future years.