Money and Finance

Lessons From Buffett's Tesco Mistake

As I read through the 2014 Berkshire Hathaway letter last weekend, one section stood out to me as being full of great investing lessons.

Here's the passage:

Attentive readers will notice that Tesco, which last year appeared in the list of our largest common stock investments, is now absent. An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling.

At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. Our cost for this investment was $2.3 billion, and the market value was a similar amount.

In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.)

During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.

While it was nice to hear Buffett's thoughts on his mistake with Tesco, I was surprised that he started the story at year-end 2012, as it's important to consider the full timeline of the investment.

Buffett started his position in 2006 and owned 3% of the company by the end of that year. At the time, Tesco was led by CEO Terry Leahy who, over a 14-year tenure, more than quadrupled the company's pre-tax profits and its store count. The company set its sights on international expansion in the U.S. and Asia and established a dominant share of the U.K. grocery market. Things were looking up for the business.

In June 2010, however, Leahy surprised the market by announcing his retirement. He was replaced by lifelong Tesco employee and head of international operations, Phil Clarke.

Tesco struggled over the next eighteen months, as the U.S. operations floundered and U.K. discount grocers began chipping away at Tesco's market share on its home turf. And despite a profit warning after a bad 2011 Christmas trading season, Buffett increased his stake in Tesco to 5.2% in January 2012. Many observers, including yours truly, thought that this investment amounted to a vote of confidence in Tesco management and its business prospects.

Around the same time, however, Neil Woodford, a well-known UK fund manager, announced he had sold his entire Tesco stake after owning shares for the better part of 20 years. He also laid out a compelling case for why Tesco had lost its way, wasn't practicing smart capital allocation, and was battling structural headwinds.

I point this out to illustrate that there were some well-founded and known concerns about Tesco's management and competitive advantages -- two core components of Buffett's investment philosophy -- in early 2012. I would be interested to know at what point between his increased investment in 2012 and when he began to "sour" on management in 2013 that Buffett began to rethink his Tesco thesis.

Here are some of the key lessons I take from Buffett's Tesco mistake:

Every investor makes mistakes. Even Buffett. The key is to recognize them, correct them as quickly as possible, and learn from them.
CEO changes matter. When a very successful CEO retires or leaves a company, it's time to reassess your investment thesis. Specifically, it's important to figure out the quality of the hand the new CEO has been dealt (i.e. how strong is the business?) and the skill with which the new CEO can play the hand (i.e. how strong is the CEO at capital allocation?)
Doing nothing is doing something. It's important to be patient, of course, but even though you may not be buying or selling a stock, you're still making an active choice to hold. If you have concerns about key points in your thesis, doing nothing and hoping the problem goes away on its own isn't a good strategy.

Related posts:

Top quotes from the 2013 Berkshire letter
Learn to love your investing mistakes
Why I sold this dividend stock for a loss

What I've been reading this week:

Takes on the 2014 Berkshire letter - Cullen Roche, Interactive Letter (WSJ), Epicurean Dealmaker, Monevator, 25iq
Revisiting a thesis on Constellation Software and a missed opportunity - Valueventure
Scarcity - Reformed Broker
Remembering 109-year old investor Irving Kahn - Telegraph
The blind forecaster - Morgan Housel
How the driverless car could impact the insurance industry - WSJ
The man who could own Aviva France - FT Alphaville
Competitive advantage and annual letter - Matt Brice
There are no guarantees when it comes to life (or investing) - Abnormal Returns
A trust that's held the same stocks for 80 years - ValueWalk

Stay patient, stay focused.

Best,

Todd

Subscribe to Clear Eyes Investing by Email

- Berkshire Hathaway Raisess Tesco Stake To 5.1%
Billionaire investor Warren Buffett increased his stake in Tesco Plc (TSCO) to 5.08 percent after a slump in the share price of the U.K.’s largest supermarket chain. Buffett’s Berkshire Hathaway Inc. (BRK/A) raised the holding from 3.21 percent and...

- An Important Dividend Cut Case Study
Back in March, I explained why I sold my position in Tesco for a 22% loss. Looks like it was the right move. As of this writing, the stock is down another 25% from my selling price. Worse, the company recently reduced its interim dividend by...

- 3 Ways To Get Better At Selling Stocks
Show me somebody that has a stop-loss order of 10% below their purchase price, and I'll show you someone that's guaranteed to lose 10%. - Peter LynchIn many ways, selling a stock is a tougher decision than buying one. A quick look around Google,...

- Why I Sold This Dividend Stock For A Loss
As the saying goes, the most valuable investing lessons are learned from observing other investors’ mistakes. Or something like that. Well, have an investing lesson on me, as I’ve made a pretty decent mistake in my portfolio. Earlier this week,...

- High Yield Reads 3/22/14
Happy Spring. Summary of recents posts and pieces of interest, sometimes enduring, to dividend investors: Jason Zweig: on the downsides of share buybacks. Looking at the Russell 3000 he reports that after the index went up 33.5% and trades at a...

Money and Finance