I have received countless e-mails like these two:
"We are holders of Berkshire Hathaway -- quite a bit of it in fact, as my wife works at Gen Re. How do you explain Buffett's oft-repeated contention that he does not understand technology stocks and therefore does not own them? What is difficult to understand about technology, especially a stock like Microsoft, where Buffett and Gates are known to be good friends? If anything, Buffet should have bought Microsoft, since it is a 'toll-collector' like many of his other companies. Moreover, how can he ignore technology stocks given their growing role in the economy? I think Buffett is becoming a bit of a relic by refusing to take time to learn about technology stocks."
"There is one thing that I find ironic. One of the reasons Buffett has invested in such companies as Coca-Cola and Gillette is because he felt that he understood the businesses so well and that he could predict future earnings for these companies. Events of the past several years have shown that this was not true as both Coke and Gillette have had real problems. These companies have not been as predictable as once thought. Too bad he and Charlie did not sit down about 10 years ago and say 'let's learn what this technology stuff is.' After all, they are very bright people. They then may have invested in a company like Microsoft that has shown to be very predicable."
Rather than attempting to answer for him, I'll let Buffett answer for himself by quoting his responses to questions on this issue during the Q&A sessions of the last two annual meetings (the transcripts are from Outstanding Investor Digest). After reading them, I'm left with a great deal of respect for Buffett's discipline, self-awareness, and humility -- and I hope some of it rubs off on me.
Absence of Change
"We think [new technology] is very beneficial from a societal standpoint. Our own emphasis is on trying to find businesses that are predictable in a general way as to where they'll be in 10 or 15 or 20 years. That means we look for businesses that in general aren't going to be susceptible to very much change. We view change as more of a threat investment-wise than an opportunity. That's quite contrary to the way most people are looking at equities right now. With a few exceptions, we do not get enthused about change as a way to make a lot of money. We're looking for the absence of change to protect ways that are already making a lot of money and allow them to make even more in the future.
"When we look at a business and see lots of change coming, 9 times out of 10, we're going to pass -- whereas when we see something that is very likely to look the same 10-20 years from now, we feel much more confident about predicting it. Take Coca-Cola. It's still selling a product very, very similar to one that was sold 110+ years ago. The fundamentals of distribution, talking to the consumer and all that sort of thing haven't changed at all. Your analysis of Coca-Cola 50 years ago could pretty well serve as an analysis today.
"We're more comfortable in that kind of business. It means we miss a lot of very big winners. But we wouldn't know how to pick them out anyway. It also means we have very few big losers -- and that's quite helpful over time. We're perfectly willing to trade away a big payoff for a certain payoff." (1999 annual meeting.)
Circle of Competence
Even if technology companies offered the long-term certainty Buffett seeks, he still would not invest in them. He explained why at the 1998 annual meeting:
"I don't want to play in a game where the other guy has an advantage. I could spend all my time thinking about technology for the next year and still not be the 100th, 1,000th or even the 10,000th smartest guy in the country in analyzing those businesses. In effect, that's a 7- or 8-foot bar that I can't clear. There are people who can, but I can't.
"The fact that there'll be a lot of money made by somebody doesn't bother me really. There's going to be a lot of money made by somebody in cocoa beans. But I don't know anything about 'em. There are a whole lot of areas I don't know anything about. So more power to 'em.
"I think it would be a very valid criticism if it were possible that Charlie and I, by spending a year working on it, could become well enough informed so that our judgment would be better than other people's. But that wouldn't happen. And no matter how hard I might train, I still couldn't. Therefore, it's better for us to swing at pitches [that are easy for us].
"Different people understand different businesses. The important thing is to know which ones you do understand and when you're operating within your circle of competence."
I urge you to think about your circle of competence. Understanding it -- and not straying beyond it -- is one of the most critical elements of successful investing.
We Do Our Own Investing
Invariably, Buffett is asked why he doesn't hire someone to invest in tech stocks if he doesn't understand the sector well enough to do it himself. He replied:
"We will never turn our money over to somebody else. If we're going to lose your money as Berkshire shareholders, we're going to lose it ourselves -- and we're going to come back and look you in the eye and tell you how we lost it. We are not going to say this game is too tough -- so we'll give our money to somebody else. You don't need the intermediaries of Charlie and me to do it for you." (1999 annual meeting.)
Future Disappointment in the Tech Sector
At the 1999 annual meeting, Buffett also warned investors about the dangers of the richly valued tech sector, using some basic and irrefutable math:
"In the whole United States -- which is, by far, the most prosperous country in the world -- there are probably around 400 companies that are earning $200 million a year after taxes, and you could probably name 350 of them.
"Five years from now, instead of 400 being on that list, there'll probably be 450 on the list -- maybe 475. And a lot of those will be companies that are earning between $150 and $200 million today. So there'll probably be 20 -- or some number like 20 -- that come from nowhere.
"If you look at the number of companies selling today at a price which implies $200 million or more of earnings right now, you'll find dozens and dozens of such companies in the high-tech arena. A very large percentage of those companies aren't going to fulfill people's expectations. And I can't tell you which ones, but I know there won't be dozens and dozens and dozens of these companies making a couple of hundred million dollars a year. And I know they're selling at prices that require them to be making that much money or more. But it just doesn't happen that often.
"It's not that easy to make lots of money in a business in a capitalistic society. There are people that are looking at what you're doing every day and trying to figure out a way to do it better, underprice you, bring out a better product or whatever it may be.
"And a few companies make it. But here in the U.S., after all of these decades and decades and decades of wonderful economic development, we still only have about 400 companies that have hit the level that would be required of a company with a market cap of $3 billion. And yet some companies are getting $3 billion of market cap virtually the day they come out. You want to think about the math of all this."
I think I know what Buffett would say about Palm's $53 billion market cap at the close of its first day of trading earlier this month
Berkshire Hathaway's Embrace of Technology
While Buffett won't invest in tech stocks, Berkshire Hathaway's operating companies -- which now comprise the majority of its business -- have embraced technology and the Internet very successfully. In fact, Berkshire was recently ranked by PC Week magazine as number 12 of the top 100 leading-edge users of Internet technology (out of 2,600 companies surveyed). Click here for links to the excellent websites of Berkshire's companies.
I've never understood the no-technology criticism of Buffett. If the critics understand Microsoft and want to share in its future, then they can buy the stock! Why cast aspersions on Buffett? I'd rather pick my own tech stocks or money managers than have Buffett do it for me. In fact, the day Buffett starts buying these stocks is the day I sell my Berkshire Hathaway.
-- Whitney Tilson
Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. Mr. Tilson appreciates your feedback at Tilson@Tilsonfunds.com. To read his previous guest columns in the Boring Port and other writings, click here.