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The Inevitables of Tech: Part I

 In a 1996 letter to shareholders, Warren Buffett defined a breed of companies that he calls "The Inevitables."

Companies such as Coca-Cola and Gillette might well be labeled "The Inevitables." ... No sensible observer, not even these companies' most vigorous competitors, assuming they are assessing the matter honestly -- questions that Coke and Gillette will dominate their fields worldwide for an investment lifetime.

Invest like Buffett
Buffett is famous for refusing to invest in technology, with IBM being the lone exception in his portfolio of mostly financial or consumer-oriented equities at Berkshire Hathaway. Buffett's reasoning: He simply doesn't understand the field.

Given our understanding of tech stocks, can we invest in a similar manner, applying the "inevitable" label to any technology stocks? Let's start by evaluating two favorite companies in the field: Google  (NASDAQ: GOOGL  )  and Apple  (NASDAQ: AAPL  ) .

The moat around search
Google owns desktop search holding a 67% market share in the United States, and slightly higher worldwide, standing at 68% -- and that's with the Chinese government doing all it can to ban Google services. 

Android dominates the mobile market with an 81% market share. In fact, unless you own a Windows Phone, when was the last time you remember using a search engine besides Google on your mobile? Google search approaches monopoly status on mobile. With Android only getting better, Google's search fortress seems more secure than anytime since it went public a little more than 10 years ago.

Failed competition
Microsoft has attempted to keep Google at bay by pouring billions into Bing, resulting in quarterly reports stained with the red ink of its Internet services operations. Despite Mr. Softy's massive outflow of cash, Google remains dominant. As for Yahoo!, it gave up trying to compete long ago, instead choosing to save money by outsourcing its search to Bing.

The only company that truly poses any real threat to Google's profit center is Facebook, which, with the vast vast vast amount of data garnered from its users, is almost certainly trying to build a search engine of its own.

As Google derives 96% of its profits from search and advertising, and continues to dominate both desktop and mobile, Google is as close to an "inevitable" as one could possibly find in the field of technology.

Contestant No. 2
According to Forbes, Apple's brand is the most valuable in the world. It has millions upon millions of adoring fans, and the company that Steve Jobs built is still one of the world's most innovative.

Yet, is it an "inevitable?" Apple has been riding high since it introduced the iPod, and continues to roll out innovative, brilliantly crafted and created products. Reading reviews of its current hardware, you'd be hard-pressed to find an honest negative review.

Yet, when looking at the landscape in hardware, you see it littered with corporations like BlackBerry that a few years ago would have been deemed by many to be an "inevitable." Unlike search, Apple hardware will continually morph into something new, and while its brand, size, and distribution channels will give it a huge advantage, there is far more room for a disruptive mousetrap to garner attention and fans.

Therefore, Apple falls slightly short of being a Buffett "inevitable."

The bottom line
Both companies are solid investments, with Apple being by far the cheaper of the two with $150 billion dollars in cash on a stellar balance sheet and a P/E of less than half of Google's. Also, as Google's gross profit approaches 60%, and Apple's stands at 40%, Apple has to grow revenues at a higher clip than Google to pad the bottom line. Google trades at a higher multiple in part because its primary profit generator is so well protected, and the company uses those profits to fund its moonshot ventures, one of which is almost certain to pay off in a big way for shareholders. I remain long on both corporations.

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  • Report this Comment On January 22, 2014, at 4:27 AM, JbUps wrote:

    If Apple were to introduce its own search this fortress that Google has would immediately begin to crumble. iSearch would be able to do what Bing and Yahoo have not. Google is a one trick pony and Apple is the one company that could do the same trick. Certainly Google would retain much of the seach add dollars but Apple would capture a good chunk for itself. Then which company looks most volnerable?

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