Charlie Munger On Dexter Shoes And Handling Mistakes

by: Paul Novell

Mistakes are part of investing. There's no way around it. So you might as well expect mistakes eventually, learn from it, and move forward. Just make sure that those mistakes don't set you back so much that you can't move forward.

Being properly diversified is one way to do that. In other words, you can make a few mistakes, but your other investments make up for it and more.

Margin of safety is another. Leaving room for error goes a long way in reducing losses.

After this year's Daily Journal Annual meeting, Charlie Munger stuck around for more questions. He was asked how he handles learning from mistakes, which led to another question on Dexter Shoes. Here's what he said:

Question: Is there a good systematic approach to learning from one's mistakes so you don't repeat them? Is there something that's worked for you in terms of post-mortems?

Charlie: We were active enough so we had some mistakes to remember. It's hard to learn, we learned a lot vicariously cause it's so much cheaper. But we also learned a lot from unpleasant experience. And just doing it, you'll automatically get those mistakes. Nobody can avoid them. Of course, you'll learn from every one. Mohnish is good at post-mortem-ing his mistakes.

Question: What did you say when Dexter Shoes came up? Were you for it or against it at the time?

Charlie: Well, I didn't look at it very hard. The company, it was loved by all the retailers. It was the number one supplier to J.C. Penney (NYSE:JCP). It had surpassed everything. It was a solid earner. It dominated Maine. They were nice people.

And of course, the Chinese hadn't come up by that time and they just came up so fast. And they just took no prisoners in the shoe business. And they weren't just cheaper by a little. They were half priced. And of course, the shoe business is not that easy a business. Of course, people bought the half-priced shoes. And the business just went to hell very fast. But that business, because it created such a huge lesson and it looks awful in terms of what the Berkshire stock is worth - I mean, we're the main charity in Maine, if you call us - but the time it was 2% of one year's performance is what we lost by having it go to zero. So our return from one year went down by two percentage points. Now, to be sure, if we bought our own stock instead of this thing, you know we're not giving away our stock, it's a huge error. But we learned from it.

I just think, if you just keep going, you'll make some mistakes and, of course, you'll learn from it. How could you not learn from that one? We learned how awful it is to have somebody who's really way lower priced come in hard and how no amount of managerial skills could protect us. Now, we have other shoe businesses in little niches that make $20 million a year or something after taxes. Maybe a little bit of that is leftover Dexter even. But we made do.

But don't you all have mistakes? That are painful? And don't you learn from them? And isn't that good?

Buffett addressed the cost of the Dexter Shoe mistake in the latest annual letter. Here's what he had to say:

I earlier described our gradual shift from a company obtaining most of its gains from investment activities to one that grows in value by owning businesses. Launching that transition, we took baby steps - making small acquisitions whose impact on Berkshire's profits was dwarfed by our gains from marketable securities. Despite that cautious approach, I made one particularly egregious error, acquiring Dexter Shoe for $434 million in 1993. Dexter's value promptly went to zero. The story gets worse: I used stock for the purchase, giving the sellers 25,203 shares of Berkshire that at yearend 2016 were worth more than $6 billion.

I won't comment on Dexter, since Charlie and Warren explain that lesson well.

Charlie cites activity early on helped speed up his learning process. In a sense, lack of activity can hold you back. If you're only adjusting your portfolio every few years, then those lessons get stretched out. Even the typical mistakes made by average investors - buy high, sell low, chasing returns, fear, greed, etc. - tend to follow the market cycle. How many cycles will it take before a lesson is learned?

The alternative is to learn from other's mistakes. The one thing that separates the great investors from the rest is their willingness to share their failures and successes. Focusing on their failures helps you in knowing what to avoid.

Of course, the painful lessons are the ones that get seared into your brain. That's probably why people equate mistakes with losing money.

But in a world of probability, that's not always the case. You can make the right decision and still lose money. You can also make the wrong decision but make money. Dumb luck and skill get confused sometimes. Being able to recognize both possibilities will make you a better investor.