- Warren Buffett prefers to invest in companies which operate in fairly stable and certain environments. Technology sector is the last place to look for certainty.
- He values certainty of returns more than the potentially huge but risky returns.
- He believes predicting the economics of the fast paced technology sector is far beyond his competency, probably a strong reason for his avoidance of the sector.
Warren Buffett has often been in the news for avoiding investments in the technology sector, which has been viewed by many investors as a highly lucrative sector. The Oracle of Omaha has his reasons for this approach. We look into reasons for his avoidance of the hot stocks.
Warren Buffett has historically preferred investments in sectors or companies which are unlikely to experience major changes. In his 1996 letter to shareholders he stated,
“We are searching for operations that we believe are virtually certain to possess enormous competitive strength ten or twenty years from now. A fast-changing industry environment may offer the chance for huge wins, but it precludes the certainty we seek.”
Warren Buffett loves to have certain but stable returns over potentially huge but risky returns. In the same letter he also states:
“Obviously many companies in high-tech businesses or embryonic industries will grow much faster in percentage terms than will the inevitables. But I would rather be certain of a good result than hopeful of a great one.”
It shouldn’t be assumed that Mr. Buffett despises change. He is only averse to change when evaluating as an investor. In his own words:
“Charlie and I welcome change: Fresh ideas, new products, innovative processes and the like cause our country's standard of living to rise, and that's clearly good. As investors, however, our reaction to a fermenting industry is much like our attitude toward space exploration: We applaud the endeavor but prefer to skip the ride.”
In his 1999 letter to Shareholder’s Mr. Buffett highlights the fact that he and his partner Charlie prefer to operate within their level of competence and identifying a durable competitive advantage in the technology space is beyond their combined expertise. In Buffett’s words,
“Our problem -- which we can't solve by studying up -- is that we have no insights into which participants in the tech field possess a truly durable competitive advantage. Our lack of tech insights, we should add, does not distress us. After all, there are a great many business areas in which Charlie and I have no special capital-allocation expertise. If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter. Predicting the long-term economics of companies that operate in fast-changing industries is simply far beyond our perimeter.”
Has Warren Buffett’s stay out of the technology sector impacted the returns of his investments? Well let’s look at the numbers over the last two decades. The chart below compares the 20 year CAGR of the S&P 500, Berkshire Hathway (BRK.A) book value per share and Berkshire Hathway Market value per share.
20 year CAGR in S&P 500 and Berkshire share price and book value
Berkshire’s book value per share has grown at a CAGR of 14.6% over the last 20 years (1993-2013) while the Market price per share has grown at a CAGR of 12.7%. This growth has solidly beaten the S&P 500’s 20 year CAGR of 7.1%. It is clearly seen that Buffett’s decision to stay away from the technology world hasn’t hindered the performance of his investments. And what is the secret of the Oracle of Omaha?
Warren Buffett has this great quality which investors often call ‘Discipline.’ It is clearly evident in his avoidance of the technology sector, even during the boom of late 1990’s, when every other person was investing to set up a business which had something to do with internet. Though in hindsight Buffett had the last laugh, non-entry into what appeared to be a highly lucrative sector is a proof of the Oracle’s discipline. There are notable exceptions in the technology world, where stocks like Apple & Google have created tremendous value and returns for shareholders. Apple stock price has grown at a 10 year CAGR of 36.7% while Google stock has grown at a 10 year CAGR of 27%. While critics could view these as Buffett’s big misses, we view it as a proof of his disciplined approach to investing. Sticking to your rules is hard to do and that is something every wannabe successful investor needs to learn from the Oracle of Omaha.
In conclusion, Warren Buffett side stepped the tech boom for the following reasons: Buffett was uncomfortable investing in companies operating in rapidly changing environments; He could never find the competitive edge in any technology companies that he felt was durable; and as he admitted, forecasting the long term business economics of internet companies was beyond his competency.
We at Amigobulls live in the exciting world of technology stocks. While we salute the Oracle of Omaha for his discipline and wisdom, we will continue to make our humble attempts to apply his principles in the technology sector and pick value stocks from this sector. We invite our readers to let us know their experiences with technology stocks. Happy investing with Amigobulls.
NOTE: Warren Buffett did finally invest in a tech company. He made IBM one of his largest holdings during the Great Recession of 2007 to 2009. Is he right in holding the IBM stock?