In a 1998 lecture at the University of Washington, billionaire best buds Bill Gates and Warren Buffett explained why tech stocks trade at lower multiples than others and why Buffett avoids them altogether. Here are some of the main points.
Buffett takes a long-term view on his investments, and he only invests in companies he understands. His investing strategy, he said, involves looking for companies whose products and business models would not change over the course of 15 to 20 years.
In other words, he is attracted to companies with products that will continue to be competitive and desirable for many years to come. He highlights a few of the companies he had invested in (through Berkshire Hathaway), including Coca-Cola, Dairy Queen, and Gillette-all prime examples of companies addressing perennial wants and needs.
Buffett explains that the Internet, while useful, is volatile. Tech firms, as Gates said, must always be on their toes because of the intense competition in the sector. This means that tech offerings are ever changing and the marketplace can change drastically from year to year.
This is why the two agree that tech stocks should trade at lower multiples. The future of tech is (wonderfully) unpredictable.
Warren Buffett: "I look for businesses in which I think I can predict what they're going to look like in ten or 15 or 20 years ... Take Wrigley's chewing gum. I don't think the Internet is going to change how people are going to chew gum... I don't think it will change whether people shave or how they shave."
Bill Gates: "I think the multiples of technology stocks should be quite a bit lower than the multiples of stocks like Coke and Gillette, because we are subject to complete changes in the rules." (Quotes via Felix Salmon)
Looking for tech stocks currently trading at low earnings multiples? Here is a list of companies with Price-Earnings-to-Growth (PEG) ratios between 0.7 and 1.0 that have seen significant institutional buying during the current quarter.
List sorted according to net shares purchased by institutional investors as a percentage of the share float. (Click here to access free, interactive tools to analyze these ideas.)
1. Mercury Computer Systems
4. Rudolph Technologies
6. Spreadtrum Communications
7. Neutral Tandem
8. The KEYW Holding
9. First Solar
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.
Kapitall's Becca Lipman does not own any of the shares mentioned above. Data sourced from Finviz and Fidelity