2021: What mistake did Buffett make in valuing Precision Castparts?

BECKY QUICK: This question comes from Asher Haft in Brooklyn who says Asher has been a shareholder since 2006. It says that he appreciates your honesty and candidness when it comes to explaining costly errors you made. In this year’s Chairman letter, you discuss that you made a mistake in 2016 when calculating Precision Castparts’ average amount of future earnings, which resulted in Berkshire overpaying to acquire it. It appears that Precision’s earnings declined substantially in 2020 because of the pandemic and the effect of airline and travel industry. What calculations could you have made in 2016 that might’ve altered your decision to acquire it? Secondly, are the problems Precision is currently facing larger than the pandemic?

WARREN BUFFETT: Well, Berkshire didn’t make the mistake. I made the mistake, incidentally. Anytime we look at buying a business, we’re evaluating the competitive strengths of the business, the price we have to pay, the management we got, everything. We didn’t make a mistake on the management, but in terms of the earning power on average. When Boeing has troubles with a MAX, well, that’s a probability. I mean, anytime any customers that big, I mean, all kinds of things are going to happen. We have seen some of those things happen, and therefore I paid too much in relation to average earnings. It’s a terrific company. I’m happy with the management and everything, but GE doesn’t need as many engines as we thought they’d need. They get into the power business and a variety of things. We knew they were in the businesses, but we did not think those businesses would necessarily be in something close to a depression when other businesses that we bought end up sometimes doing better than we think. We’ll continue making mistakes. I mean, I shouldn’t say we will, I will, but even these-

CHARLIE MUNGER: The rest of us will help.

WARREN BUFFETT: We’ve got some wonderful deals and some terrible deals. The nice thing about it is, as I pointed out, that this doesn’t really apply in the case of Precision precisely, but when we’re disappointed in a business, it usually becomes a smaller and smaller percentage of our business just by the nature of things, because it isn’t going any place. When we got a successful business, like a GEICO or something of the sort… GEICO, they’re doing 15 times as much business as when we bought control in 1996… they become a proportionally much more important part of our mix. You really get, through just natural forces, you get more of your money in the things that have developed more favorably than you thought. You actually end up getting a greater concentration in the ones that work out. It’s not, like Charlie would say, it’s not like having children. I mean, the bad will cause you more problems. In the children of businesses, the small ones kind of… with the way.

We started with three businesses, Charlie and I. Berkshire was textiles. Diversified Retailing was a department store, and trading stamps, Blue Chip business. Those were the three companies we put together. All three of the original businesses failed, which sort of gets me in terms of the people that are worried about don’t we know that coal is going to be phased out over time. Of course, we know coal’s going to, but that doesn’t mean we’re going to be phased out over time. I mean, every business has some things to think about that way.

The biggest danger, they have that section in the perspectives called… what do they call that about certain-

GREG ABEL: Risk factors.

WARREN BUFFETT: … risk factors, yeah. The number one risk factor, you never see it. The number one risk factor is that this business gets the wrong management, and you get a guy or a woman in charge of it that they’re personable, the directors like them, they don’t know what they’re doing, but they know how to put on an appearance. That’s the biggest single danger that a business has, and that that person stays and runs it for 10 or 15 years, and either stays in the textile business, a department store business, and expands. I’ve looked at a lot of businesses and that’s what’s caused the number one problem. It isn’t the kind of thing where they list them all, because the lawyers tell them to list them.