Dear reader,
I came home with wet socks today.
The shoes I bought last year let the rain in. They were cheap, which was about all the comfort they offered while I was peeling them off.
Next time I’ll have a reason to buy something else.
That small disappointment sent me back to Dexter Shoe, the company Warren Buffett bought in 1993. Dexter had spent decades making shoes people wanted, it supplied the big retailers, and for a long time it had been up against cheaper imports.
Buffett liked the people who ran it. He thought the business would keep doing well.
He paid $433 million for it.
Years later he admitted he was wrong. And because he paid with Berkshire Hathaway shares, the mistake ended up costing a hell of a lot more than that price suggests.
I wanted to know how that could happen, so I went back through his letters. Not just the later ones, where he explains what went wrong, but the ones he wrote when he still thought Dexter was a great buy. I wanted to see why he was so sure, and what the rest of us can take from what came afterwards.
One question kept coming back as I read.
Was it just a bad year for the company, or was something happening that it would never recover from?
Hold that thought. First, let me tell you about the people who built Dexter.
Before the mistake had a name
Harold Alfond was working in a shoe factory at 20, earning 25 cents an hour. In 1956 he started his own company, Dexter, with $10,000, and two years later his nephew Peter Lunder joined him.
By the time Berkshire took it over, Dexter was making more than 7.5 million pairs of shoes a year, mostly in Maine and it ran 77 stores of its own. Big retailers like Nordstrom and J.C. Penney had given it awards for being a good supplier.
Buffett also had a reason to feel at home in shoes. He had bought H.H. Brown in 1991 and Lowell Shoe at the end of 1992, and both had done better than he expected.
In his 1993 letter he praised Dexter’s managers and said the company could compete with cheaper shoes from other countries, even though it cost more to make shoes in America.
Now put yourself in his shoes (sorry). A company built up over many years, people who know the job, customers who want the product, and two other shoe companies that had worked out well. You’d feel good too.
But the story contains one big guess.
Dexter had beaten cheaper shoes before. Buffett assumed it would keep doing it.
Every time you buy a share in a company with a good track record, you’re making the same kind of call. You can look at what it earned last year, or ten years ago. The money you’re hoping to get, though, comes from years that haven’t happened yet, and somewhere between the two you have to make a judgment.
The danger was already in the room
It would be a much simpler story if cheap foreign shoes had turned up the day after Buffett signed.
They didn’t.
In his 2001 letter he explained that Dexter had done well against tough, low-cost competition from other countries, both before Berkshire bought it and for a couple of years afterwards. His mistake was believing it could carry on like that.
Think about what that means. Nobody sneaked up on him. The danger was in the room the whole time, and he could see it.
Most company reports have a section listing the risks: competition, rising costs, changing customer habits, a weaker economy. They’re all standard. But a list like that only tells you what could happen. It doesn’t say how likely it is, how much damage it would do, or whether the company can cope.
Here’s the simple version. Somebody else could make the same shoe for less.
That doesn’t kill a company overnight. People may love its shoes, the stores may like its service, and new ways of making shoes may close some of the gap. But those good things have to be strong enough to matter when a rival says, “Ours is cheaper.”
Past success tells you the company dealt with yesterday’s problem. It says nothing about tomorrow’s.
While reading I found something else, a sentence Buffett wrote in March 1995 about a different mistake in a different business. I’ll show you in a moment.
First, 1995.
That was the year the shoe businesses made much less money. Berkshire gave a reason, and it sounded reasonable, even a little reassuring.
I’ll show you the numbers and the reason. Then you tell me whether you’d have believed it.
Subscribe free to keep reading. Next: the numbers from 1995 and the reason management gave, the sentence Buffett wrote about another mistake, and why paying with shares made the mistake so costly.