Inefficient growth

Find out why looking at profit growth alone could be detrimental

- Karthik Anand Vijay

Known as the ‘Oracle of Omaha,’ Warren Buffett is one of the most successful investors of all time. So, unsurprisingly, we consider him a great teacher of investing. His letters to shareholders and annual shareholder meetings are a treasure trove of knowledge.

However, even great minds make mistakes and there is much more to learn from mistakes than success. In this story, we delve into one such mistake made by this legendary investor and what we can learn from it.

In his shareholder letter for the year 2014, Buffett acknowledged that he made a ‘big mistake’ by investing in Tesco (a British supermarket chain). After increasing its stake in Tesco from 2.9 to 5.2 per cent during 2006–2012, Berkshire Hathaway had sold its entire stake by the end of 2014.

What led to this dramatic turn?

As mentioned by Buffett, the company lost market share, its margins contracted and accounting issues cropped up. We looked at Tesco’s operating profit, net profit and ROCE and found something interesting (see the graph ‘Tesco’s performance over the years’).

While the company’s operating profit grew at about 12 per cent per annum during February 1998–2010, its ROCE was on a steady decline (from 17 to 12 per cent). It indicated that Tesco was able to grow its profits only by employing more capital. Indeed, the company was on a debt binge, with its debt increasing by 21 per cent together, if possible per annum.