This Disruptive Start-Up May Trash Your Thesis

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Warren Buffett is well known for avoiding technology investments. Though it could be argued that there are a few exceptions in the Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) portfolio, it's mostly made up of boring businesses that change very little over the years.

This, of course, is part of Buffett's strategy. Buffett once said, "we see change as the enemy of investments ... so we look for the absence of change. We don't like to lose money. Capitalism is pretty brutal. We look for mundane products that everyone needs."

The scenario I'm about to describe is the perfect example of why I think Buffett avoids fast-changing industries.

How Can You Compete With Free?

I recently outlined what I thought was a bullish case for Rosetta Stone (NYSE: RST). My thesis revolved around a very cheap stock combined with a powerful catalyst set to manifest itself in the near future.

The catalyst? The company's Online Learners, or individuals who use Rosetta Stone's online platform, have increased 167% year-over-year, to 57,000. This is clearly a favorable development for shareholders. Online Learners save the company two major expenses: (1) retail and (2) packaging and shipping.

In the company's most recent earnings call, management even went out of its way to explain that these numbers were not supported by "meaningful marketing spend." Rosetta Stone's prepared remarks for its FQ3 earnings call go on to say that, "As we go into 4Q and 2013 and begin to put our marketing muscle behind the online offerings, we think there exists significant opportunity to further penetrate the market and speak to those customers that prefer an online duration-based service."

Outstanding, right? I'm not so sure anymore.

A few days ago my wife showed me an App called Duolingo. She said she discovered the App through Tim Ferriss' blog. Then she showed me an article citing a study that showed Duolingo users only take 34 hours to learn a first college semester's worth of Spanish. Rosetta Stone users, on the other hand, took between 55 and 60 hours.

But she didn't stop there: "It's free."

I insisted that there must be a catch. So I did some research. There is no catch. In fact, not only is the service free, but it is a profitable business model too. As learners progress through the programs, they are literally translating the internet. In a sense, learners are Duolingo employees working for free.

The backers? The company recently launched a new $15 million funding round. Early backers include Ashton Kutcher, Tim Ferriss, and Union Square Ventures.

Talk about a disruptive company – my whole Rosetta Stone thesis just went out the window.

Avoiding Disruption

Scenarios like this are a blunt reminder that maybe Buffett really knows what he is talking about. After all, the "Oracle of Omaha" is the world's greatest investor.

If fast-changing industries keep you up at night, here is an alternative strategy to finding slow-changing businesses with great investment prospects: coattail investing

As defined by Investopedia, coattail investing is an "investment strategy in which investors mimic the trades of well-known and historically successful investors."

One way to do this is to take a look at what the value investing greats are investing in, particularly Warren Buffett.

In Berkshire's Sept. 30, 13-F SEC filing, the company revealed that it added 16.7 million shares to its Wells Fargo (NYSE: WFC) position. Berkshire's 7.8% stake in Wells Fargo now amounts to $13.96 billion. Wells Fargo has mostly outperform ratings by The Motley Fool Caps community, the all-star players, and Wall Street analysts.

Plus, the stock currently has a nice 2.86% dividend yield. Arguably the most stable publicly traded bank, the dividend is highly reliable. Though there is only 11% upside to the consensus price target of $39.90, the bank's limited downside makes the stock a great investment.

The Bottom Line

Watch out for disruption. If it bothers you too much, stay far away from fast-changing industries. One way to do this is to keep an eye on what the great value investors, like Warren Buffett, are investing in. With Berkshire's recent addition to its second largest holding, Wells Fargo, the bank could make a good bet for investors looking to minimize risk.

On that note, I'll go ahead and make an outperform CAPS call on Wells Fargo right now.


The Motley Fool recommends Berkshire Hathaway, Rosetta Stone, and Wells Fargo. The Motley Fool owns shares of Berkshire Hathaway, Rosetta Stone, and Wells Fargo. 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.

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