Reflection on Buffett Way – Technology

I always regret that I did not buy Google Shares at its IPO, when it was about $85. It’s now $571, almost 7 times of the IPO price 8 years ago. I was using Google for searching all the time and believed that it dominated the searching business and was doing the right thing on almost all the aspects. The only reason I did not buy is because Warren Buffett doesn't buy technology companies whose value are difficult to estimate. He also doesn't invest at companies whose track record is not long enough and whose business not easy for him to understand. While I do understand Google‘s business at the time with my IT background, Google didn't have much track record and the growth of it business was indeed hard to project. Therefore it’s difficult to estimate its value.

Indeed, it perfectly all right to miss the opportunity to buy Google at its IPO based on Buffett’s way. However, no investor should rule out technology companies from his investment portfolio in this era, because these are the companies which generate high returns and high growth year after year, such as IBM, Google, Apple, Oracle, Microsoft (though slower growth now for some of them) and so on. Certain type of IT business is not too difficult to understand, as the companies I mentioned here. The real challenge is the projection for future growth, which affects the valuation of the stock. Due to the quick change of technology landscape, it’s indeed not only difficult to predicate the growth of a company in this area, but also the success or failure of such company. A good example is Research in Motion which had a serial of very successful products, BlackBerry phones, until Apple's iPhone came to the market. On the other hand, will Apple continue its success for long? It's very hard to predict.

I often recall one particular incident, when I think or talk about investment and Apple at the same moment. One day in 2004, I was having lunch with my friends and their wives, among which one was an engineer in Apple, in a restaurant, while a big iPod advertisement was right in front of us on the top of opposite building. With the growing popularity of iPod, we inevitably mentioned about investing in Apple stock. I said that though iPod was an excellent product, the company depended too much on Jobs, and therefore it's a risky business to invest in the long term. I then mentioned more about principles of investments and financial freedom. The Apple guy admired Jobs and was obviously not very comfortable with my comments on Apple’s prospects. However, all the others were very much interested in my talking and even started asking whether it's wise to buy certain stocks, as if I am kind of God, who can foresee the near future of all the stocks. The ladies showed so much enthusiasm that their husbands suddenly became very quiet. We all knew what happened to Apple and its share price afterwards. None of my friend at that lunch has contacted me since then. I also do not feel comfortable to make the first move. Apple's success shows that my comment about its prospect was so wrong. If any of my friends had bought apple shares right after our lunch discussion in 2004, he or she would be about 20 times richer now.

In fact, I was not wrong on investment principles. It only Jobs made me looked like a fool. Jobs created a serial of miracles over these years, making not only one excellent product after another, but also changing games. If only one company had come out with one product better than iPod, or iPhone, or iPad, I would not be like a fool in the eyes' of my friends at the lunch. However, no one has made anything better than Apple over the period. With so much talented people and powerful companies around in this world, I could not imagine this is the result.

What happened to Research in Motion and Apple are good examples of how difficult to predict the future of a technology company. However, the growth potential is not always unpredictable for certain high tech companies, especially for software and IT service companies. When a software product starts to dominate the market, it will grow quite steadily over many years before the market getting saturated. This is because the cost of changing software is very high in the sense of users having to re-learn the replacement. People can just pick up any mobile phone to make a call without any pain to re-learn the calling process, while no one really want to learn how to use another spread sheet, instead of Excel. In addition, the reliability of software is more important than hardware. When a hardware product is not working properly, users will notice it almost immediately. On the other hand, when a software product is not working properly users may not even notice it. In an extreme case, users may lose money directly if the software involves with money transaction. Therefore, brand of software is much more meaningful than hardware. It’s much more likely that users will stay with the software they are already using.

Microsoft's Windows and Office software are such examples. No other products have ever changed their dominating position so far, although cloud computing can be a real threat. Again, it’s the way of computing, not another product from other companies affecting Microsoft’s core business. People will most likely keep using the Office online without paying a penny to Microsoft. Microsoft had steadily growth in 1990s before them becoming too big and the market for Windows and Office software becoming saturated. Google is another good example. I don't see any real threat in near future for Google's search business. Although there is not much pain for users to use another search engine, the trust is a major factor here. It’s a good demonstration of brand power of software here. However, when Google started to get into other businesses, it was hard to project the profit growth of the whole business.

For IT service companies, no matter what hardware or software changes happened in the market, it is their people, who can quickly learn the new technology product or concepts and then implement it in their services, make the difference. It is people where their competitive edge is, not particular hardware or software. In this sense, IT service companies are no different from conventional service companies. Quality System is a good example. They have a group of software systems for digitalizing medical records and managing various hospital or clinic functions. The growth of their business is around 20-30% annually and they are still growing. Once hospitals or clinics installed Quality System's software, they are going to keep it, upgrade it and add on more functions, so long it works. Changing into another software product is a painful experience once the staff are used to the current one. In the case of new products of hardware or software in market, Quality System people will learn and figure out whether and where the new products can be implemented into their customers' system. New products become new selling points for IT service companies, instead of killing the existing business in most of cases. Certain high-tech products may become obsolete over night, while the needs of customers of IT service companies wont. The famous Infosys Ltd and Cognizant Technology Solutions Corporation are also good examples of IT service providers growing steadily over many years with high returns.

All in all, it’s well worth the effort to understand the different nature of high-tech businesses and spot those companies having relatively predictable growth potential with some unique competitive edge. Many businesses in the technology field are not that difficult to understand like rocket science, especially when you only need to have a macro view of the business. Warren Buffett must also realize this and bought IBM finally, breaking his record of not investing in high-tech companies.

Back to Apple story, I think the best time for Apple is over. iPad is more like a toy than a useful tool. It is the fantasy created by Apple over these years pushing the sale of iPad. I don’t think Apple TV will be a game changer like iPod. The short coming of Apple products is their incompatibility to other systems, which creates inconvenience for serious users of computing devices. Openness and compatibility is a deciding factor on the long term success for high-tech companies. Microsoft’s Surface tablet will be a serious challenge to iPad. Windows 8 will run on PC, tablet, mobile phone and notebooks, achieving software convergence. Therefore, Microsoft will have a competitive edge in the next several years over its competitors in this area.

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