The Cost of Dawdling
Lessons from Buffett's Tesco mistake — and a framework for knowing when to sell
At a former firm, I’d soured on one of the stocks I brought to the fund and recommended that we sell for a loss.
A few months later, COVID happened and the stock was a prime beneficiary. It roughly 5x’ed from our selling price.
I felt awful.
My boss had a great perspective on it. We had good reasons to sell and we would have made the same decision with the same information. Move on.
In the short-run, luck drives the majority of our returns. Over time and many iterations, however, skill should shine through. The product of well thought out decisions should tilt the scales in our favor in the long run.
Even knowing this doesn’t make it easier to manage a troubled position.
Troubled stocks force an internal debate that requires the right balance of introspection and action. If the scales fall too heavily on one side, it can have disastrous effects.
Sell too quickly and you prevent yourself from holding onto a potential winner. Defer a decision for too long and you can further impair your capital.
The topic of selling a troubling stock has been on my mind recently, as I’m struggling with what action to take - if any - on some current holdings that are down between 20-40% in an otherwise strong market.
This internal debate brought to mind Buffett’s commentary in the 2014 annual letter about the poor outcome of his Tesco investment.
Ultimately, Berkshire took a $444 million after-tax loss on Tesco - one of the worst outcomes in Buffett’s illustrious career.
Here’s what he said in the letter:
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.
Buffett's mistake, though painful, contains some useful lessons.
Focus on the moat: Moats are never static - they are either getting wider or narrower each day. As Buffett noted with Tesco, it was losing market share and margins contracted during a UK grocery industry price war. Not a good setup for widening the moat. A good question to ask yourself here is, “Do I think the company’s products or services will be at least as relevant to its customers in 3-5 years as it is today?”
Take management changes seriously: Undiscussed in the quote above, Tesco made a big CEO change during Berkshire’s holding period. When Buffett first bought shares in 2006, 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. In 2010, he announced his departure at a highly uncertain time for the company. It’s true that successful CEOs have the right to exit the stage, but the succession process should be well communicated and orderly. Unexpected leadership transitions deserve deeper scrutiny because they can reveal underlying business challenges.
If your confidence in the company’s moat or management wanes, it’s time for an honest reassessment of the investment.
One way to soberly evaluate your current view is to ask yourself, “With each new interaction with the company or new bit of analysis, am I becoming more or less confident?”
If your confidence is weakening because the moat is narrowing, the culture is deteriorating, or management is damaging your trust, sell and move on.
Why? Because if you have lost confidence and the stock tanks thereafter, you’ll feel twice as bad. You knew better and still took the opposite decision. You intentionally shifted your mindset from investing to hope and hope is not a sustainable investment strategy.
What’s more, you’re tying up your capital in a stock you don’t have confidence in when there are thousands of alternatives for which that wouldn’t be the case. In other words, there’s an opportunity cost for dawdling on a decision.
The best way to frame the decision is, “Would I still buy the stock today at the current price at the same weight as I currently have in my portfolio?”
This question naturally incorporates valuation. It's possible the moat has weakened slightly, but the stock has declined even more. In that case, the shares could still be attractive today, albeit at a smaller weight than before.
If you wouldn’t buy the stock today at its current weight, sell and move on. Good decisions don't always lead to good outcomes, but that's a risk every investor has to accept if they hope to be successful in the long run.
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Stay patient, stay focused.
Todd
Todd Wenning is the President & CIO of KNA Capital Management, LLC, an Ohio-registered investment advisor that manages a concentrated equity strategy and provides other investment-related services.
At the time of publication, the author, his immediate family, and/or KNA Capital Management, LLC or its clients own shares of Berkshire Hathaway.
Please see important disclaimers.
We deal with this in venture. When things aren’t working, we are liable to spend way too much time trying to fix the mistake. The reality is that venture isn’t a turnaround business and we should just focus on our winners. Otherwise we are just dawdling on our losers.
well said.