What You Can Learn From Warren Buffett About Internet Bubbleshttp://www.fool.com/investing/general/2014/03/30/what-you-can-learn-from-warren-buffett-about-inter.aspx Travis Hoium
March 30, 2014
Snapchat recently turned down $3 billion from Facebook (NASDAQ: FB), it took $19 billion to buy WhatsApp, AirBnB is reportedly valued at $10 billion, and the maker of Candy Crush recently went public -- and even after dropping from its IPO price it still has a $5.8 billion market cap. If this sounds like the gaga days of the late '90s, it's because another tech bubble is forming right before our eyes.
When companies start using metrics like "daily users" or "messages sent" to display their value instead of figures like revenue and profits, alarm bells go off in my head. The good news is we've been through this tech mania before, and there's a blueprint for how to survive it.
We don't have to look further for guidance than the legendary Warren Buffett, who was considered out of touch when the tech bubble formed in the late '90s and came out with a better reputation after the bubble popped. Here are a few lessons Buffett taught us to avoid Tech Bubble 2.0.
Beware of paying big for growth in tech
We've seen this story before, and we know it doesn't end well. In the last bubble, Yahoo paid $5.7 billion for Broadcast.com in 1998, making Mark Cuban a billionaire. In social media, there was News Corp.'s acquisition of MySpace for $580 million, only to be sold seven years later to Specific Media and Justin Timberlake for $35 million. Paying big for potential growth without a sustainable competitive advantage is dangerous for investors.
Why Buffett wins long-term
When the Internet bubble finally burst and the market crashed, it was Buffett who had the last laugh. The reason is that at the end of the day, profits matter, and so do the sustainability of those profits.
The bubble currently building in tech valuations isn't the same as the late '90s one, because there are some viable businesses with decent competitive moats, but for every Google there's a Zynga or Groupon. Facebook's or Twitter's (NYSE: TWTR) moat is really just about popularity, and unless they can continue to stay popular and grow they'll go the way of MySpace, Internet has-beens.
How does Buffett do it?
Here I've provided the price-to-book value, price-to-sales, and price-to-earnings ratios, all commonly used measurements of value for stocks. You can see that by any measure these companies are trading at lofty valuations.
Now compare those ratios with Buffett's five largest holdings, which trade at much more reasonable valuations and have survived the financial crisis and come out stronger.
Notice the competitive moat these companies have, particularly Coca-Cola (NYSE: KO), American Express, and Procter & Gamble (NYSE: PG). Coca-Cola is a global brand that has an incredible amount of shelf space at grocery stores worldwide, something that's taken decades to build. American Express has a huge credit card network that would be nearly impossible to replicate or replace. And Procter & Gamble makes products that are called consumer staples for a reason -- you couldn't get by without them.