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Humanizing Tech

"The Reason Warren Buffett Never Invested in Tech" in Humanizing Technology

Warren Buffett, the investor extraordinaire, and owner of Berkshire Hathaway.

In one word: tangible assets.

Okay that’s two words. You can replace tangible with “real”. Or any other word that means something physical that you can hold and touch. Like cash. Like inventory. Like property. Like equipment. Like the money people owe you but haven’t yet paid you for.

Real assets = real value

That’s half of how you value a business. Add up all the stuff lying around. Assign it a price someone else would pay for it. That’s part of what you would have to pay for the business if you wanted to buy it outright.

For example, Nike has shoes. Lots and lots of shoes. They also have clothes. And office space. That’s a lot of value.

But think about Facebook for a second. Or Snapchat. Before it had any ads. There wasn’t a business. And there wasn’t much in the way of a real tangible thing that you could assign a price to. You had some office space and some computers. But you didn’t have inventory. And nobody owes you money. In fact it was quite the opposite. Investors gave you money with the expectation that some day you would pay them back. With interest.

So if you like up Facebook against Nike, which one is more valuable? Nike doubled sales every year for decades and that’s called Super Exponential Growth. Facebook did something similar except it wasn’t doubling the sales of shoes. It was doubling the number of people who used their product.

And so, when you actually compare the two one another on a spreadsheet, you see that Facebook has only a tiny fraction of its market value held in real tangible things while Nike has a much larger percentage. I did the math for a few companies in the tech space to show how varied and wild the valuations of public companies are, not even private companies like Snapchat or Uber.

I’ve broken them down into 5 Tiers:

  1. Value almost entirely based on the price of real assets on the company’s balance sheet
  2. About half the value of the company in real assets
  3. About a third in real assets
  4. About a quarter in real assets
  5. Almost no real assets

What’s interesting is how you start to look at competing tech businesses when grouped into different buckets like this:

  • T-Mobile seems like a confident buy if we believe that they will begin stealing a large number of customers from AT&T and Verizon.
  • Apple, because they sell a physical product, has a lot of tangible value.
  • Under Armour and Tesla hold a lot of physical inventory and manufacturing equipment/facilities, but Microsoft seems to be an outlier here, even though they have begun making physical products and not just selling Office 365 subscriptions. Tesla is dangerous, even with 400,000 pre-orders of the Model 3 because they have no cash.
  • NVIDIA, Google, Nike, and Amazon couldn’t be more different in terms of types of businesses. One makes GPUs, another has a search business with ads, another sells shoes and the last one ships products and sells infrastructure services. And yet they all have a similar amount of assumed growth in their market value. Which one would you rather own?
  • Lastly, almost the entire value of Facebook is built on the expectation of massive future growth because they have almost no real assets.

So why didn’t Buffett ever invest in technology? Because he saw that, for the most part, tech companies didn’t have much in the way of real tangible assets. Their market value, and therefore price, was propped up based on an expectation of massive future growth, much like what you see above with Facebook. There is an inherent risk in that. Namely, they might never grow, the stock crashes, and the company fails.

This is exactly what happened during the Dot Com Boom & Bust in the late 90s and early 00s. Lots of greed without a healthy dose of fear.

What you’re really looking to do is find a company with a great product, run by incredible managers, that seems to spit out more cash than it takes to run the business. Essentially a high Free Cash Flow and Return on Invested Capital.

It’s better to have a product that people need to keep re-upping on than one you buy once. Almost like a subscription. That’s why Buffett loves insurance companies. People pay a premium every month and as long as you offset that with accurate actuarial productions of loss from disaster, you should be good to go. He also loves Sees Candies. That’s how he got his start. A massive cash producing business.

If you ever find a company where the real assets are worth more than the market price of the company, then buy the company and sell it off. You’ll make whatever the difference is. That’s called the breakup value.

And that’s what the original movie Wall Street that pitted Bud Fox against Gordon Gekko was all about.

Bud Fox vs Gordon Gekko

Be wary of Mr Market. You always have to believe someone’s trying to pull the wool over your eyes. Do the analysis yourself. Don’t leave it to a gut feeling or some other analyst who may have entirely different incentives than yourself.

— Sean


The Reason Warren Buffett Never Invested in Tech was originally published in Humanizing Technology on Medium, where people are continuing the conversation by highlighting and responding to this story.

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from Sean Everett on Medium http://ift.tt/24wlEKO