Case Study: Berkshire Hathaway–Avoiding Value Traps
At his annual meeting with investors Mohnish described a project he had undertaken to help him improve as an investor. The project was designed to help him learn from the decision making process of successful fund managers:
"From the period of 2004 to 2010 we scanned all the 13F filings and all the public filings for Davis Funds, Oakmark, Third Avenue, Longleaf, Fairholme, Baupost, Greenlight, ESL, Pershing, Brave Warrior, Oak Value and Wintergreen. If you track the 13F filings quarter after quarter, you can see changes that are made in the portfolios. We looked at where the company added a brand new position in a quarter which wasn't in the 13F last quarter. We then looked at the next quarter to see if there was a change in the number of shares. If the number of shares went up, then we knew they continued buying. In our analysis, we assumed that they were buying evenly throughout the quarter and came up with an average price. This probably isn't reality, they probably had more sporadic buying, but I don't think those deltas are very large. We focused on the investments where the company had completely exited the investment. They held the investment, then at some point they completely sold the investment, and the investment was no longer on the 13F filing. During the 6 year period, we went through and extracted all the data about the gains and losses over all the positions that these funds held. We could clearly see the ones that they made money on. We could also see the ones that they lost money on, and approximately how much money they made or lost. On that list of mistakes, which is a long list of mistakes, we found 363 mistakes."
In the annual meeting Monish was asked to elaborate further:
Question: My question is when you went through the checklist analysis looking at the mistakes of these star investors, what were some of the more like common ones or ones where you saw a lot of managers making the same mistake? And then the other part is, I know it's hard to analyze this, but what about mistakes of omission where a lot of investors say those are the big ones. From your insight and your experience what are maybe one or two things that you can think of to help us as investors.
Answer: Those are good questions. What I'm doing with the checklist doesn't help me on the omission side because we're not able to see those. And maybe the best lessons are on the omission's side. In terms of some of the lessons, one thing I found very strange is when I look at Longleaf Partners whom I respect a lot. They're a great shop, and do great work. And then I see they make an investment in GM. When I see them invest in GM (GM) I'm saying, "Okay, so do they not see that this is unionized? And do they not see that they have no differentiated products? And do they not see that you've got a very bad, labor management relationship?"
So I'm scratching my head about why would you go into something like GM when you know there's a whole bunch of items where any benefits from that business are unlikely to come to the shareholders. They're more likely to end up with employees and the unions. I listened to their commentary of why they invested in GM and the commentary was about how GM owns the truck business. Toyota doesn't have a place in the truck business and GM owns the truck business and that's so big and so important.
One of the things I came out with was that sometimes you can look at the trees and miss the forest. I found that in some of these investments that Longleaf was making they would find some glimmers of a great business inside these huge companies. And of course the truck business went to hell because gas prices went up and people stopped buying SUVs and trucks.
One of the checklist questions that comes out it is that are you missing the forest from the trees? Are you focusing too much on a few trees and not looking at the forest? Another example is with Dell. You know again Longleaf invested in Dell (DELL) and, in fact, they still have Dell. They have not exited their Dell position and they're still very bullish on Dell. One of the changes that came about with Dell was the change from desktops to laptops. When you change from desktop to laptop, you take away the advantage Dell has in assembly. The traditional Dell model was that you place an order, then they start building the computer and they ship it to you.
Well, with laptops you really can't do that. It doesn't quite work the same way a computer does, and the whole assembly and parts and all that is somewhat different. Then you go to the next step where you're going from desktops to laptops to smart phones. And you go to iPads and that advantage continues to decline.
Longleaf will say you have to look at their enterprise business, you have to look at their server business, and you have to look at the storage business. Those are doing well, and okay maybe in the end it works out. But count me as a skeptic. What I found is that sometimes there was an emphasis on the trees. Another example is with Davis Funds.
There was a question asked by one of the investors to Mr. Davis after Hank Greenberg left AIG (AIG). "Is this a meaningful event that this person who built this amazing company is no longer here?" And their response was completely relevant. This is a great set of assets and brand set, and of course one of the problems we know very well with levered financial institutions is that you have to be very careful in how they're run.
In hindsight what we can see with AIG is clearly no one was minding the store too carefully, where one group in London takes the whole thing down. One of the things I focused on with the checklist was to know what data was visible before the investment was made that would stop you from making the investment.
The important thing about the checklist is that it's not data that comes out later. It's data that's with you today. So what was visible about AIG is that Hank had left. You can handicap that in whatever way you want to. The second thing that was absolutely clearly visible about AIG is that it's a levered financial institution in insurance and there are very, very few insurance companies that in the long run are decent businesses. I don't know whether that would have been enough to stop it but those are the data points that come out.
I'm still going through and flushing through these. Sometimes when you see these very large losses being made by very smart investors, I find that sometimes they've fixated on the wrong variables. They really should have fixated on some different ones and that would have created maybe a different outcome.