I'm going to file this in the "no shit" drawer. Buffet is notoriously conservative and his shareholders (I'm one) understand that. I think the more people are talking about a given company, the less likely Buffet is to invest in it.
That's not to say that those companies will fail, he's just not going to be the one betting on it. Many highly risky bets will pay off but he will not be sad that he missed it.
The less like a insurance company or business model that's 200+ years old, the less likely buffet is to invest in it. He seems to specialize in troubled traditional businesses which are mainly missing capital investment and insurance
That's not really accurate. Warren just only invests in companies with strong (provable) profit models at cheap prices. It doesn't matter what it is, it matters whether he (or you, or I, or anyone) can look at the numbers without guessing and see profit.
Before the housing bubble burst, those mortgage-backed securities were being shopped to Buffet. Buffet said he wouldn't buy them because they were bundled millions of loans and he had no way of knowing what the health of those loans actually was. Not rocket science. Not new age, high tech or too young for him. Just no different than anyone should even be with their money.
Would you buy a car for $25K if you did not know what year the car was, what model, what it looked like or what condition? But that is essentially what they were asking Buffet to do. And he didn't...but several people did.
Passing on random financial instruments (which AIG Was a counterparty to quite a few of) is not the same thing as commenting on a social networking site or choosing to not invest in something tech related.
Saying something is overvalued is buffet speak for saying "not cheap enough to be troubled" which is when he traditionally invests in things.
He buys lots of family businesses upon death events, and some heavy industry suffering capital issues. Generally speaking, this precludes young firms from crossing his radar even. "Suffering capital issues" is similarly something you will rarely see in todays tech environment.
Because a person is good at something doesn't mean he does everything perfectly. There are lots of great investments out there Buffet is not going to go anywhere near, that are conservative even. He definitely has a profile far more constrained than "proven business model"
He's a good businessmen, no doubt about it, but because he dislikes something does not mean it's not a good bet, it just means it doesn't clearly fit into his "Nothing a little money can't fix" investment profile.
NetJets doesn't fit that bill, but might be the exception that proves the rule. Also, "troubled" probably isn't the right modifier; he famously invests in managers in addition to proven businesses; he isn't a turnaround guy. How many companies has BRK bought where he replaced the CEO?
Capitalization troubled. Family businesses who have an owner die, railroad needing capital to expand, financial services company needing more marketing cash, etc.
You are right, he rarely replaces people. But when a business owner dies, and heirs need cash, guess who's there looking at the business to buy it?
Also, it's not like a simple 3 line answer completely encapsulates his entire investment strategy. I'm just pointing out a typical thread that runs through many of his investments.
I'd be interested in knowing which of the companies he sold were from "motivated sellers". But in the meantime: distressed shareholders are not the same thing as a distressed business. Also: every business is capitalization-troubled compared to BRK. :)
There are more, but this is enough to show a bit of a pattern.
And you do have a good point about distressed shareholders vs distressed businesses. But either one can drop the sell price (aka, make them undervalued).
After that quote I actually re-read the section in the Snowball where they talk about Mrs. Blumkin (Furniture Mart).
1) The business wasn't distressed and was doing great.
2) Mrs. B was growing old and her son Louie had taken over most of the work, she was still active in managing the carpet section
3) They were looking at a German company to take them over; their offer was $90.0 mn
4) Buffet told them they would get a higher valuation if they waited and then laid out the pros and cons of Berkshire being in charge. Also pointed out that many other firms would have managers which would inevitably try and run the show.
5) BRK wanted them on as partners to run the firm, without bringing someone in from the outside, which is something both Louie and MRs. B wanted. She didn't want to sell to a German company, being a Russian immigrant.
5.1) T His is generally BRK policy, it invests in strong, track record proven companies and teams, after doing massive amounts of diligence on them.
6) She then told him she wanted $55.0 mn in cash, for 90.0% of the company.
7) Buffet signed, with the caveat that if she wanted to change the deal she could. She said no.
8) Her son and his grandson stayed on and helped grow the business.
9) At some point Mrs. B got very irritated with her growing lack of control, and when her son/grandsons overruled her on a carpet purchase decision she got mad and left.
10) She started her own business opposite the road and began to beat Furniture mart. Since Buffet did not take sides she was quite hurt and betrayed.
11) BRK pays her $5.0 mn for the name of her new mart, makes sure shes happy and in charge of furniture mart, and ensures her non compete clause is bullet proof.
Its an interesting story to read about, as is Mrs. B - she also had a laser focus on her expertise; she didn't care to go beyond it, and was extremely effective within it. She also made decisions quickly and never looked back.
Funnily, 20% of the stake was held by her daughters, and her sons-in-law came to sign the deal. They were aware they would get more if they signed with the Germans but Mrs. B basically harangued them into submission - "how much do you want, I'll pay ya".
Her management style was... interesting - Buffet had been told that she wanted to sell the place 20 years earlier. When he got there to sign the deal, Mrs B. had part of her office (may have been sons/in laws) lined up, just so that she could yell at them and call them a bunch of bums. Once she abused them enough, Buffet was allowed to walk away.
IIRC, in the biography I read about him, he had the opportunity to invest in pre-IPO Intel, but turned it down because it was a market he didn't get, so he definitely does "lose some" from time to time, but on the whole, it seems to have worked out "ok" for him.
When we're talking about the kinds of companies BRK gets involved in, they are all businesses that you can reasonably expect to be around in 50 years. It's not just a "buy low, sell high, time the markets" strategy. To a certain, hyperbolic, extent, might not the difference between timing INTC and IPET just be granularity of time scale?
Remember the part about the airline industry talk? I can't help but see parallels in quite a lot of tech companies.
In 2008, he said:
The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.
The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it. And I, to my shame, participated in this foolishness when I had Berkshire buy U.S. Air preferred stock in 1989. As the ink was drying on our check, the company went into a tailspin, and before long our preferred dividend was no longer being paid. But we then got very lucky. In one of the recurrent, but always misguided, bursts of optimism for airlines, we were actually able to sell our shares in 1998 for a hefty gain. In the decade following our sale, the company went bankrupt. Twice. (http://www.berkshirehathaway.com/letters/2007ltr.pdf)
There're similarities, but also quite a few differences as well. Airlines are a commodity business: the service Southwest sells is essentially the service United sells. Tech at the micro scale is very much differentiated: the service DropBox sells is very different from the service that AirBnB sells, which is very different from the service Google sells.
Tech is also weird in that software development has significant diseconomies of scale, while software operations has significant economies of scale. Small teams can develop a product faster, but once the product exists and has been proven in the marketplace, it's cheaper to scale from 100 servers to 100,000 servers than it was to go from 1 server to 100 servers. This has historically fueled the cycle of small tech startups being founded, gaining traction, getting bought, and then the founders quitting to found other small startups. It's economically rational for them to do so, because they can develop a product faster with a small team than inside a big organization.
I'm curious how the existence of cloud-hosting like Amazon EC2 will change this market. That's had the effect of splitting software development and software operations into separate markets: before, it used to be cheaper to integrate them into one firm, but now a commodity product exists that makes it feasible for the development firm to remain independent and simply pay a fee for all the operations support.
I suspect it's actually bad for startups in the long run, much like the power loom was bad for textile manufacturers. Since there're economies of scale to operations, that side of the market will tend to a few big players (right now Amazon has a virtually monopoly, and only a couple others even have the capability to offer something like that), while the startup side will tend towards many small firms. In a situation like that, the big firms have all the bargaining power, and so most of the profits will accrue to them.
Softwae is capital-intensive as well in that it usually takes a significant amount of labor to build out a product to the point where it can generate revenue. Just because the capital tends to be paid out in salaries instead of purchases doesn't make it capital-cheap.
That's a really insightful comment that has turned my thinking on this area of economics on its head. It sounds like any business is capital intensive if it involves paying lots of people high salaries in order to do it, even if the salaries are the business's main cost.
Of course, software development doesn't have to start out capital intensive. A couple of kids working on their startup in a cheap apartment can work cheaply. They can defer the capital intensive part until they are successful. An airline doesn't have that option.
Capital is not necessarily money paid. If those two kids have the talent to create a successful website they are incurring opportunity costs due to the fact that they could be earning a decent salary with those skills rather than creating a startup.
Yeah, but the 'stair steps' are way smaller. To start an airplane business, you need to go in with some big bucks to get things off the ground. To start a bingo card business or a bug tracking system or a project management system or a lot of other things, you can get by with a lot less, and ramp up as needs be.
But don't you have to pay for servers, electricity, support, lawyers, etc? (I really know nothing big of the social web business, I'm a game developer trying to understand it).
Electricity, support, lawyers, and (with cheap 1u intel servers and ec2) servers are costs which scale with demand. You don't have to spend money on those if you don't have money coming in the door. One airplane is really expensive. If you're an airline you're forced to make bets on future demand which you might lose, and the likelihood that you'll lose is higher when the market for your services is volatile (as in times of high growth).
It's all relative. Airplanes are more expensive than servers, but the revenues of airlines are gigantic. United Airlines turned $23 billion revenue in 2010. Southwest did $12 billion. What's Twitter's revenue compared to what they've sunk in servers, development costs, etc.?
Airlines may have pretty big revenues, but their profit margins are tiny, and at the end of the day, net profit is what matters to investors. In 2010, Google only made $30 billion in revenue, which is only a tiny bit more than Delta airlines made. But Google is worth $184 billion, while Delta is only worth $8 billion.
The costs of servers scale extremely well, while the costs of airplanes and jet fuel don't. So web companies have much higher potential profits than airlines, and they're consequently worth a lot more.
So web companies have much higher potential profits than airlines, and they're consequently worth a lot more.
This isn't a competition between tech companies and airlines. Airlines merely act as an example an industry which, at least as of 1995 when Buffett first brought them up, had a net loss over the entirety of the industry's existence. What's the net lifetime profit of the tech sector? What will be the lifetime profit of social websites in another ten years?
That's really it, Buffet doesn't make bets, he takes sure things when no one else wants them. This is why he always under performs the market in booms and outperforms during busts. He finds the companies he likes and waits for the price to be right.
There is also a lot of synergy in his investments, if you look at Geico part of the reason they are able to offer such low rates is that they park most of their excess funds with Berkshire or other similarly outperforming investments.
Or look at BNSF and their trackage to the Powder River Basin. He doesn't want to be in a company like Facebook because he doesn't know that they will be around in 20 years, nor are their competitive advantages (network effect) durable within the industry. Look at a company like Coca-Cola, their advantages are durable and customer base loyal. Coca Cola doesn't need frequent drinker miles to get their customers to remain loyal.
One of the highly overlooked benefits of long term investing is the tax implications and associated transaction fees. If you buy and sell stock frequently you pay capital gains so any other investment needs to be better than the one you currently have by at least the capital gains you'll pay on the sale plus the brokerage fees.
And yet, people will still put money into it. Despite so many people, including very-often-right-even-when-the-economy-is-tanking Warren Buffet saying they are too expensive, people will put in money and claim ignorance and bamboozle-ment when it doesn't work out.
It's pretty clear Social Networking sites are overvalued. Facebook has a valuation of around 65 billion $ on revenues of around 2 billion $. Microsoft has less than 4 times the valuation of Facebook and more than 30 times the revenue.
I actually agree that prices may be inflated/overhyped but the lack of specificity in Buffett's statement kind of irks me. He doesn't even define what a social network is (Facebook, Zynga, and Groupon are all remarkably different companies and not everyone would consider all of them to be social networks).
He's a brilliant investor but at the end of the day statements made without any indication of real analysis or research should be taken with a grain of salt...even from the Oracle of Omaha.
Buffett: "One of the things we try very hard to do at Berkshire, is to stay within what I call our circle of competence."[1] It would surprise me greatly if the social network sphere is within Buffett's circle of competence, and it would surprise me even more if he thought it was, and so I would interpret his comments about it accordingly.
Everything you say is accurate. At the same time it's worth listening. Buffet's got a great understanding of business models in general and knows a lot more about high tech than people give him credit for -- starting with a close friendship with Bill Gates. Yes, it was a very general statement and I would love to know more but take it for what it is: he's recognizing a couple patterns (most stocks badly overvalued, hard to pick winners) that he's seen; and it seems like nobody's convinced him yet that they're on the short list of winners [or he probably would have mentioned them]. So, while he's not necessarily right, it's still very valuable input from a strategy perspective.
Also, Buffet is not some old fashioned, technology ignorant day trader. He claims he doesn't know much about technology companies, but he was still the first one to predict the internet bubble and is well involved in the modern markets. I think he's just speaking relative to his knowledge of other industries. No one doing as much market research every day as he does "only knows about industries 100 years old."
The main question is how will these companies grow?
When google went public everyone thought it was overvalued, because the perception at the time was they were top of their game, and had nowhere to go. Of course they proved everyone wrong and became so much more then they were. Google is a great example of a software company using a public offering to help expand the company.
So the the question is, which of these companies can become more than what they currently are. What does Facebook need cash to accomplish? Can Groupon push in to every continent? Can Twitter become more than a microblogging service?
Considering that Google doesn't pay a dividend and has only had around 25% revenue growth in comparison to Apple (71%). I would say they haven't proven anyone wrong yet. People have bought up Google and sent the stock price soaring, so it was a money maker for people who speculated on whether people would keep buying it. But stock market pricing and underlying stock value as it relates to the company are often wildly disconnected. There are companies which dwarf Google in profits, revenue and dividend whose stock price is in the 20s or 30s.
This makes some sense. We often rate social networking sites demand-side, by how much potential people see in them rather than how much they're actually worth. The fact that the still growing Groupon is worth over 6 times as much as the well established and influential Twitter is a perfect indication of this. Worth is still somewhat based on assets and popularity, and we shouldn't push the price of companies up by such huge factors simple because they ARE growing and haven't established a reliable estimation of worth yet. Startups are a venture market, where the real money is made before sudden explosions in popularity, but we shouldn't grossly over rate them just because they aren't already well established, and the explosion hasn't happened yet. Especially because if the explosion does happen, and the company is worth at or less than its estimated, demand-side, potential worth, nobody's making money anyway, because the stock price won't have increased much. In other industries its called poor evaluation to treat EVERY up and coming business like its going to explode, why should startups be so different? Because SOME people have made tons of money? If were all "chasing the american dream" in our investments and will settle for no less, than that's acceptable. But if were trying to invest intelligently, its unjustifiable that every up and coming startup is grossly over rated in price. Unless Groupon actually has around 22 billion dollars in assets, then they do not have a justifiable price. Otherwise, we need to listen to the Oracle of Omaha and wise up. Startups are still an industry, and we need to get used to that to avoid bubbles like this. Maybe venture capital is so hard to break into because you ACTUALLY need to look for companies that aren't popular yet, rather than just decide to invest in the companies you use every day. The strong investments are made before the company is well known, not before it has an accurate price.
Groupon is worth a whole lot more than Twitter because it has a realistic way to make boatloads of money. Twitter is influential, but that doesn't mean its stock is worth a lot of money. As far as I can tell, Twitter's business plan is something along the lines of, "advertising or something?". Groupon takes 50% of the money from each groupon sold.
Crocs, Inc., the company that makes those awful rubber shoes, has a higher market cap than The New York Times Company. That doesn't mean NYT is less important than Crocs, but it does mean that it is not as good at turning a profit.
More good fodder for bubble discussions. Assume for a moment that he's right, that “Most of them will be overpriced” and “Some will be huge winners, which will make up for the rest.” This is also an accurate description of the dot-com and telecom bubbles. And this leaves the poster children like Facebook, Groupon, Quora, and now Color.xxx in a very vulnerable position: to sustain their mega-valuations they have to show that they can sustain being so so so much better than everybody else.
I'm no expert on W.Buffet, but I've read a lot about his life and investment principles. He owns companies like Sees Candy, and although I love a good ol' box of Sees around the holidays (and I admire their company), I can't help but associate my Grandmother with their products!
What I'm trying to say is that Buffet is, for me, is a generational investor - the best of his generation or even (arguably) the 20th Century, but definitely of my Grandmother's generation. He's remained incredibly relevant to a large extent based on his investment principles, looking for value bets and investing (or rather, buying) for the long run.
I, for one don't think that Facebook is overvalued at all, if you think about it's revenue potential, but Buffet invests in undervalued companies, not over-promised ones that have yet to reach their potential. Facebook's egg hasn't hatched yet in a way that justifies their evaluation, but it's easy to reconcile Buffet's investment principles with more speculative investors that see Facebook as a safe bet.
Finally - it's not hard to image a few different models that could outpace or even replace Facebook's main product proposition (providing a common, social "space"). So not many investments remain secure over a very long term. That's the brilliance of Buffet.
Also, Buffet is not some old fashioned, technology ignorant day trader. He claims he doesn't know much about technology companies, but he was still the first one to predict the internet bubble and is well involved in the current markets. No one doing as much market research every day as he does "only knows about industries 100 years old."
I think Groupon actually deserves high valuations. They actually have a clear and simple way to turn a profit. They also have a tremendous amount of business relationships that are hard to replace.
The big problem with Groupon, even compared to social networks, is that there's no network effect to help entrench their position.
Consumers might use a Groupon coupon today, a LivingSocial one tomorrow, and a Facebook one next week. There's no significant motivation for consumer loyalty.
I like Groupon too, but the Burlington Northern is going to be a significant player in freight shipping 50 years from now with a high degree of certainty. How sure are you about Groupon?
I definitely don't think they deserve the valuations they are receiving. I just think that they are much more worthy of being a public company than either Facebook or LinkedIn are. People are always going to want to save money, that demand isn't going away. People change social networking services like shoes.
I felt the same way about Facebook until I read Spolsky's "every time they figure out how to make 10 cents from their customers they get to fill swimming pools with money" comment. Facebook has also become defensible, in a way that almost provides an argument against Buffett: it's not a question of "which social network will take all the chips" (let me answer that for you: Facebook), but whether the social space is going to have a large value.
I think social networking has a viable market waiting to be launched. Imagine Facebook being Web 1.0. I think Facebook 2.0 is out there waiting to be hatched.
I believe social networking is here to stay. Advertising dollars follow where the audience is. Off line advertising is losing ad dollars year over year to follow where the people are. Today, they're online. Imagine in 10 years...
Facebook in particular, the largest player in the social networking arena by far, has a huge opportunity before their eyes. Wait for them to start executing on them. I "only" see 2 big ones: advertising and search. Yeah, I know, many people are talking about it. But that's true. FB knows everything about most of their users (600mm people), so how long until they create a competing Adsense service? Not far I think. That's a $10bn a year, at least, for FB in the next 5 years or less. Search is another opportunity that's so huge I can't even think of the size of that market.
I remember reading they have an AdSense competitor in the works, but that initial tests showed it wasn't a good enough competitor yet to be released.
I don't know if it would be $10B though, even AdSense isn't quite there for Google yet. Assuming they could lure a big chunk of AdSense publishers away, I suppose it could be several billion though.
Maybe they'll release it just before IPO to show their true promise. Name predictions... FB AdConnect?
That's not to say that those companies will fail, he's just not going to be the one betting on it. Many highly risky bets will pay off but he will not be sad that he missed it.