Why I Ignore Buffett's Advice

Seven years ago, I wrote about how cheap Apple (Nasdaq: AAPL  ) had become. Given its cash position and the likelihood of earnings doubling in the year ahead, I couldn't understand why the stock was trading for just 26 times earnings. "That seems ... illegal," I said at the time.

Fast-forward eight months. In October 2004, Apple reports a 33% increase in revenue and a 351% increase in normalized net income. The stock soars. In fact, it never looks back to see me standing there, sheepishly, wondering why I didn't take my own advice.

There's a word for this, Fool: stoopid. Not stupid but stoopid, as in comically inept. By failing to open a research position in Apple, I forfeited what today would be a 30-bagger.

The moron in the mirror
By "research" I mean "small." I'd done enough research to build a thesis. I wasn't flying by the seat of my pants. But I also hadn't fully considered management, compensation agreements, insider ownership, and other factors that I like to look at before buying. So I waited as the stock took off. And then when it did, I got gunshy.

Please don't repeat my mistake. If you like a tech stock for good reasons -- enough to develop a thesis worth testing -- buy. Don't wait; buy. Not only will you participate in the ensuing rally if you're right, but you'll also force yourself to prioritize your research and complete your due diligence. After all, you'll have real money on the line.

Wait: Didn't Buffett say to wait for the perfect pitch?
Yes, he did. What I'm telling you is exactly the opposite of what Buffett recommends. And yes, I know exactly how dangerous that is. Eschewing the advice of the world's most successful investor, a multibillionaire, isn't likely to make you richer.

Except when said billionaire admits he doesn't know your area too well, and that's what we have here. I'm talking about tech stocks -- businesses Buffett won't invest in because he doesn't have a good method for gauging what amounts to a sustainable advantage.

Don't take that as a knock on Buffett. The differences between information-technology markets and the more staid industries Buffett invests in are stark. IT businesses grow with outrageous speed and deliver returns in bursts; dividend-paying consumer products and manufacturing companies grow steadily and provide returns in a more deliberate fashion.

Act quickly to take your time
I admit, this strategy doesn't make sense for everyone. If you're the type of investor who loathes research and won't do any more than necessary, then please consider an index fund. For you, the cost of being wrong is likely to be far too high.

But if you're interested in tech and you're willing to study chips, software, storage technology, programming tools, and the reasons the Internet works the way it does -- sorry, it's not a series of tubes -- a research position can offer a surprising amount of comfort.

You won't hurry your research for fear of missing a massive rally, but you also won't be on the hook for a portfolio-destroying loss if your initial thesis is wrong. And best of all, you'll have the power of dollar-cost averaging on your side as you build your position a little at a time.

3 stocks worthy of research positions
Most often, you'll see me taking research positions in tech stocks I'm investigating for our Motley Fool Rule Breakers service. My favorites are businesses enjoying accelerating revenue growth coupled with above-average returns on capital.

Fast growers that deploy capital well are rare, and they're usually positioned to throw off massive amounts of cash flow as they reward shareholders. But don't take my word for it. Over the holiday break, I compiled a list of 10 consumer stocks enjoying accelerating growth. Here's how my top four from that list have performed so far.

Company

YTD Return

S&P 500 Average

Melco Crown Entertainment 23.57% 4.46%
Ctrip.com (2.41%) 4.46%
ChinaCast Education (17.53%) 4.46%
Netflix 30.91% 4.46%

Source: Google Finance.
* Return on capital.

Taking research positions in these stocks would have netted you a small but noticeable profit through the first quarter. Not bad, right? Despite extraordinary market volatility, you'd have lost nothing while studying a handful of businesses that could bring you multibagger returns over the next several years.

Now, here are three deeper tech candidates that fit similar criteria, with the notable exception that they also enjoy excellent returns on capital.

Company

Historic Revenue Growth (2-Year CAGR)

Estimated Revenue Growth (Next 2 Years, Annualized)

ROC*

Cirrus Logic (Nasdaq: CRUS  ) 35.4% 39.3% 19.0%
F5 Networks (Nasdaq: FFIV  ) 20.4% 26.2% 17.3%
MercadoLibre (Nasdaq: MELI  ) 25.8% 30.4% 32.2%

Source: Capital IQ, a division of Standard & Poor's.
* Return on capital.

Among these, MercadoLibre is already a winning Rule Breakers recommendation. My colleague Eric Bleeker in November singled out Cirrus Logic for his "Rising Stars" portfolio. And although F5 doesn't have the same level of Foolish support as the other two, a sharp sell-off has made the stock uncommonly affordable compared with historic levels.

You can follow all three stocks by adding them to your watchlist. Just one click is all it takes. You'll get free, personalized updates on each company as well as immediate access to a new special report: "6 Stocks to Watch From David and Tom Gardner." Simply click here to get started.

Our Motley Fool Rule Breakers service recommends buying MercadoLibre, while our Motley Fool Big Short service recommends shorting the stock. Motley Fool Alpha has an open short position in MercadoLibre. Apple and Netflix are Motley Fool Stock Advisor selections. Melco Crown Entertainment is a Motley Fool Global Gains pick. Ctrip.com is a Motley Fool Hidden Gems recommendation. Motley Fool Options has recommended that members open a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is a member of the Rule Breakers stock-picking team. He owned shares of Apple at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. You can also get his insights delivered directly to your RSS reader. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool owns shares of Apple and Cirrus Logic and has written Apple puts. The Fool is also on Twitter as @TheMotleyFool. Its disclosure policy loves you just the way you are.


Read/Post Comments (1) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 27, 2011, at 5:16 PM, Henry3Dogg wrote:

    If you understand Tech, but invest in Cola, THAT would be ignoring Buffett's advice!

Add your comment.

DocumentId: 1465262, ~/Articles/ArticleHandler.aspx, 4/17/2014 9:08:57 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 16,408.54 -16.31 -0.10%
S&P 500 1,864.85 2.54 0.14%
NASD 4,095.52 0.00 0.00%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

4/17/2014 4:00 PM
AAPL $524.94 Up +5.93 +1.14%
Apple CAPS Rating: ****
CRUS $19.05 Up +0.37 +1.98%
Cirrus Logic CAPS Rating: *****
FFIV $108.40 Up +0.09 +0.08%
F5 Networks CAPS Rating: ***
MELI $86.15 Up +1.51 +1.78%
MercadoLibre CAPS Rating: ****

Advertisement