Buffett Should Buy Google
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Warren Buffett surprised everyone last year when he publicly announced he had been buying shares of technology companies. Most notably, Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) acquired almost 5.5% of IBM (NYSE: IBM) in 2011. This was a big change at Berkshire, a sizable position in a tech company is a noteworthy departure from Buffett´s “no tech” investment philosophy.
Buffett has stayed away from technology stocks during decades; he considers them outside of his “circle of competence” which is Buffett´s way of saying he doesn´t understand tech and it’s hard for him to find companies with the best competitive advantages. A strong competitive advantage – or moat in his own words - is absolutely central to Buffet´s investment style, so he wouldn’t touch any stock unless he felt confident about the sustainability of its moat.
During the dot com stock bubble in 1998, he told Berkshire shareholders, ‘Technology is just something we don’t understand, so we don’t invest in it.’ His letter to shareholders for 2000 says on the subject of tech companies: “We have embraced the 21st century by entering such cutting-edge industries as brick, carpet, insulation and paint. Try to control your excitement.”
The tech sector has traditionally been the scenario of rapidly rising and falling stars, the owner of a booming technology today may easily be an obsolete company in a few years. But there have been some important changes in tech land during the last years, and I believe Buffett has taken notice of those structural changes.
Some companies have become too big and strong to be considered vulnerable to changing technologies from one day to another. These businesses have extraordinary brands which protect them from the competition, and if a new technology looks menacingly disruptive, they have the resources to simply buy that technology and profit from it.
IBM has the second most valuable brand in the world according to Interbrand, and that´s an important advantage when big corporations are choosing a provider of software and consulting services. It also has the money to invest considerable sums in research and development, which gives IBM a leadership position when it comes to technological advancement.
However, there is always the possibility of a new company developing a revolutionary technology that would leave IBM behind, that´s an unavoidable risk, especially in this sector. But as long as IBM´s management is smart enough to closely follow the important developments in the industry, the company should do better than fine. If the world changes IBM will probably adapt to those changes as it has done it in the past, and it has the resources to do it in the future.
Big blue has faced many important technological changes during the years, and the company has been able to make intelligent decisions in that changing environment. During the last decade IBM has adapted to the commoditization of hardware by focusing more on high margin businesses like software and services.
Regardless of the dynamic nature of the tech sector, IBM has proved it is a wide moat stock – one with strong competitive advantages – based on the value of its brands and its ability to allocate resources to the most convenient segments. Now that Buffet has found some compelling alternatives in the tech sector, maybe he would like to take a step forward and consider a younger, but very profitable company: Google (NASDAQ: GOOG)
Buffett has recently expressed in the Berkshire Hathaway shareholders meeting that he wouldn´t buy Apple or Google because he considers them too risky. That risk assessment is not based on the company´s fundamentals, but on the fact that Buffet doesn´t know enough about the companies, their potential competitors, and where technology might be going, in order to see Google and Apple as "inevitable" winners.
I believe these two companies have competitive advantages which are as strong as any of Buffett´s main holdings. Google is probably more risky than Apple, so we´ll stick to the online search giant to analyze its competitive strengths and long term prospects. The main idea of this post is that companies like Google can be considered Buffett like investments in modern times.
Google is not as stable as IBM, and it doesn´t have the same long tradition of success, but the internet giant has many characteristics that Buffett could appreciate, especially when looking at competitive advantages and brand value.
Coca-Cola (NYSE: KO) has always been considered a prime example of a competitive advantage sustained mainly by an outstandingly strong brand name. Very few companies in the world have the privilege of replacing the name of a product with their own brand, many people use the expression: “drinking a coke” instead of “drinking a soda”.
Much in the same way, we “Google” information instead of searching for it online. Google has a tremendous market share, with more than 66% of the market while competitors like Microsoft (NASDAQ: MSFT) and Yahoo have a much lower 15% and 14% respectively.
Sure, Google will face a changing environment too, computing is moving to mobile, but the company is going aggressively after those trends with its successful Android operating system for smartphones. Google is also getting a lot of traffic from iPhones, and it’s estimated that the online search giant owns nearly 90% of the mobile search market. Just like IBM adapted to changing industry dynamics, Google seems to be doing it very well too.
Warren has stated that Berkshire will see lower returns in the future due to its huge size which forces the company to invest in bigger, less attractive companies. One way in which such a problem could be avoided would be by focusing more on technology stocks, since they offer both big capitalizations and high growth opportunities. The tech sector is also populated which many attractive highly profitable companies with pristine balance sheets and convenient valuations, another aspect Buffet will surely appreciate.
The tech sector has changed over the last years; many companies have developed extremely solid competitive positions sustained by high economic moats. IBM is a clear example about how Buffet is recognizing this structural change, and if he has the courage to step further into the sector, Google may easily be considered like a suitable stock for Berkshire portfolio. Although much riskier, and with more potential, than big and steady IBM.
acardenal owns shares of Google and IBM. The Motley Fool owns shares of Berkshire Hathaway, Google, International Business Machines, The Coca-Cola Company, Microsoft, and Yahoo!. Motley Fool newsletter services recommend Berkshire Hathaway, Google, Microsoft, The Coca-Cola Company, and Yahoo!. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.