Why is Warren Buffett's only tech stock IBM?
Why is Warren Buffett's only tech stock IBM?
Circles of competence
At the 2006 Berkshire Hathaway annual meeting in Omaha, Mr. Buffett reflected on his “circles of competence” particularly as it related to technology; interestingly, he referenced IBM’s founder Tom Watson (emphasis mine):
We are best at evaluating businesses where we can come to a judgment that they will look a lot like they do now in five years. The businesses will change, but the fundamentals won’t. Iscar [one of Berkshire’s operating companies] will be better – maybe a lot bigger – in five years, but the fundamentals will be the same. In contrast, look at how much telecom has changed.
Charlie [Munger] says we have three boxes: In, Out and Too Hard. You don’t have to do everything well. At the Olympics, if you run the 100 meter sprint well, you don’t have to do the shot put.
Tom Watson [IBM’s founder] said, “I’m no genius. I’m smart in spots and I stay around those spots.” We have a lot of managers who are the same. You don’t want to compete with Pete Liegl because he’ll kill you in the RV business. But he doesn’t try to tell us how to run the insurance business.
I was virtually there at the birth of Intel. I was on the board of Grinnell College with Bob Noyce [one of the founders of Intel] and Grinnell invested $300,000 into it at inception. [I easily could have as well, but] I had no idea then and still don’t now what Intel will look like in five years. Even people in the industry don’t. Some businesses are very, very hard to predict.
Technology stocks go into his “Too Hard” bucket.
Famously, Mr. Buffett avoided technology stocks during the dotcom boom in the late 1990s and at one point was widely panned by financial media. As their stock prices soared, Berkshire Hathaway’s stock price languished and Barron’s wondered “What’s Wrong, Warren?“ Of course, we all know what followed in the coming months and years.
One thing that people often misunderstand about Mr. Buffett is that his aversion to the technology sector does not mean he is not aware of technology companies or the disruptive nature of innovation itself. He counts many of technology’s biggest names in his social circle including Bill Gates, his BFF and chief partner-in-crime in giving away massive globs of wealth. He also thinks about disruption (not just technology-driven either) all the time as it relates to his own portfolio of operating companies. From his most recent most recent annual letter where he talks about risk (emphasis mine):
Berkshire operates in more industries than any company I know of. Each of our pursuits has its own array of possible problems and opportunities. Those are easy to list but hard to evaluate: Charlie, I and our various CEOs often differ in a very major way in our calculation of the likelihood, the timing and the cost (or benefit) that may result from these possibilities.
Let me mention just a few examples. To begin with an obvious threat, BNSF, along with other railroads, is certain to lose significant coal volume over the next decade. At some point in the future – though not, in my view, for a long time – GEICO’s premium volume may shrink because of driverless cars. This development could hurt our auto dealerships as well. Circulation of our print newspapers will continue to fall, a certainty we allowed for when purchasing them. To date, renewables have helped our utility operation but that could change, particularly if storage capabilities for electricity materially improve. Online retailing threatens the business model of our retailers and certain of our consumer brands. These potentialities are just a few of the negative possibilities facing us – but even the most casual follower of business news has long been aware of them.
Mr. Buffett is also not saying that everyone else will necessarily lose money investing in the technology sector. And clearly many people have made massive amounts of money investing in the technology sector. The market capitalization of the technology sector is the highest it has ever been with companies like Apple, Google, Microsoft and Facebook valued in the hundreds of billions of dollars. All he is saying is that he would rather focus his limited time and brainpower on areas where he is a lot more comfortable and where he feels like he is more likely to create value for Berkshire Hathaway. Eveybody’s “circle of competence” is different.
At this point you might be rightly wondering then why the heck he purchased shares in IBM [1] and not only that ... why he has made it Berkshire Hathaway’s fourth-largest position?
Very simply, IBM has evolved to the point where Mr. Buffett is a lot more comfortable with his ability to peer five or more years into the future and see what IBM looks like and what the economics of its business will be.
You see, IBM is not really as much a “technology company” these days as it is a “highly competent advisor to Fortune 1000 companies around the world with complex IT needs” that happens to also be very profitable in that role. Because he’s made it such a large investment, Mr. Buffett must believe that IBM’s place in the business world is unlikely to change in the medium to long-term, or that it will change in a way that he is comfortable predicting.
It could also very well be that Mr. Buffett has incrementally expanded the bounds of his “circle of competence” by getting smarter over time about the industry that IBM plays in and IBM’s business model itself.
That highlights another important lesson about “circles of competence”: They are dynamic and can be built on over time.
Part of becoming a good investor is expanding your “circles of competence” over time. Remember when Warren got started, he invested in mediocre companies trading that traded well below their tangible asset values. He called then “cigar butts”. Over time, he has evolved as an investor and today he prefers far more to invest in “great companies at good prices”. He never used to invest in capital-intensive businesses like utilities but as Berkshire’s cashflow started getting measured in the billions, he realized that these businesses could be good ways to re-invest at a decent return (albeit not as high as his early years).
Knowledge and wisdom are cumulative and Warren at 86 years young thinks that he and Charlie (aged 92) have yet to peak.
That said, let’s also not leave out the possibility that Mr. Buffett is simply wrong about IBM. He has been wrong before and has openly admitted these investing mistakes. If he is wrong about IBM, or finds a better place to invest Berkshire Hathaway’s capital, he will definitely own up to it and most likely discuss why he was wrong in the following year’s annual letter. Usually he is quite direct about, like when he discussed his investment in bonds of a now-bankrupt power company:
Most of you have never heard of Energy Future Holdings (EFH). Consider yourselves lucky; I certainly wish I hadn’t. The company was formed in 2007 to effect a giant leveraged buyout of electric utility assets in Texas. The equity owners put up $8 billion and borrowed a massive amount in addition. About $2 billion of the debt was purchased by Berkshire, pursuant to a decision I made without consulting with Charlie. That was a big mistake.
Unless natural gas prices soar, EFH will almost certainly file for bankruptcy in 2014. Last year, we sold our holdings for $259 million. While owning the bonds, we received $837 million in cash interest. Overall, therefore, we suffered a pre-tax loss of $873 million. Next time I’ll call Charlie.
Just keep in mind that Mr. Buffett’s been far more right than he’s been wrong over his more than six decades in the industry.
Disclosure: As of February 2016, my fund owns shares in Berkshire Hathaway. It does not own shares in IBM. This could change at any time.
Note
[1] In 2011, Berkshire Hathaway began purchasing shares in IBM. As of December 31, 2015, the conglomerate owns 81 million shares in the company representing a 8.4% total ownership stake. Berkshire Hathaway has continued to purchase shares over the past year and IBM is its fourth-largest common stock position after Wells Fargo, Coca-Cola and Kraft-Heinz, worth approximately $11 billion.
This was originally published on Quora in February 2016.