I promise, this is not yet another W.E.B. post. At least, not intentionally.
Despite being, by all accounts, best buds with Bill Gates, Buffett staunchly refused to invest one red cent of Berkshire's in technology stocks (although he has admitted buying 100 shares of MSFT in his personal account just to keep track of it). The rationale was from the same scripture: buy what you know, stay within your circle of competence. Buffett's humble spin on it was he did not understand technology, him being a dinosaur from the Depression era, and could not predict where the MSFTs and CSCOs and INTCs would be 10, 15, 20 years from now. The unspoken truth was, if Buffett, capitalism's foremost genius, couldn't figure it out, no one could.
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"Technology stocks" is a misnomer. Technology is not a new phenomenon. Technology has been with humans since the beginning of time. Fire was technology, spears, agriculture, mud huts--all technology. The common thread between all of them is their inevitable deprecation in the face of new technology. Fire has given way to HVACs, spears to F-22s, mud huts to Burj Al Arabs. Equity by definition is the present value of all future cash flows, the valuation of which usually involving a perpetual, if humble, growth rate. And so, that is the true reason behind the instinctive aversion of value investors--the inability to predict when the new will suddenly become the old, when prodigious cash flows suddenly vaporize, when that assumed perpetuity becomes a big fat zero.
When you think about it rationally that way, it makes a lot of sense why one shouldn't invest in technology stocks. 99% of them are here today, gone tomorrow. For every Microsoft and Intel, there has been literally thousands of Pets.com's. To think you can pick the right needle out of a haystack made of needles is pure and simple hubris. Even venture capitalists, whose very job is to do that picking, lose 29 out of 30 times. Their success hinges on that 1 they get right, and it's gotta be a massive home run to make up all those losses and chop out a 20% return.
Ever since the bubble burst in 2000, investors have caught onto this obviousness, sending paper millionaires back home to their parents with their pockets stuffed full of worthless stock certificates. But there is a worthy exercise in examining the winners. Beyond some luck, what is it that makes a technology company wildly successful?
Paul Graham, founder of start-up incubator Y-Combinator who got rich off of selling Viaweb to Yahoo! in the tech boom, wrote a thought provoking essay titled "Microsoft is Dead". It's metaphorical death, Graham argued, is most clearly exemplified by how little technology start-ups fear Microsoft. To the brilliant hackers of today and tomorrow, Microsoft is a non-factor. They're the punch-lines of nerdy jokes. That's because they don't innovate anymore. Or at least, innovate at a pace that keeps up with the modern internet. They can't even successfully steal ideas anymore because they're so out of touch with what's cool in tech.
This was not the case in the 90s. No one was more in touch with the burgeoning wave of PCs than Bill Gates, who envisioned a computer in every home and office far before anyone else did. He built Microsoft around that vision, and although its arguable whether Microsoft is a true innovator, it was at the very least always relevant, always threatening to competitors, always relentless in the battle for market share. That's what makes a technology company successful. It needs to have that insatiable thirst to be relevant, willing to cannibalize its own products for the sake of advancing technology, and concurrently attract and strike fear into the smartest people on the planet.
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Google is that company today. And they are the only technology company I am comfortable investing in, because they fit all those criteria. Google is exceedingly relevant in our internet-centric world. The pace with which they crank out new products and new versions is astounding for a massive multi-national, and is probably a model that will be studied in detail by academics in the future. Most tellingly, it's where all the smart hackers want to work and who all the other tech companies fear will take one look at their idea, put the Google spin on it, and make them obsolete overnight.
This post was inspired by two recent articles on GOOG, one bullish, by Barron's, and one bearish, by Fortune. Fortune's bearish argument essentially rests on the claim that Google is a one-trick search pony and will be left in the dust of a socially networked future. Barron's does a decent job taking the other side of that, arguing that trading at 15x earnings, the market is barely factoring in any remaining growth, and boy oh boy, growth there will be. What they both are really trying to do is the impossible task of predicting the future.
Instead, focus on what maximizes the probabilities of continued growth. Is Google still the company everyone fears and admires? If yes, then they are still the tech alpha dog. I will always want GOOG to innovate first, profit second. The former is an unwavering dedication to the long-term view, and the latter is ambiguous. Innovation is their R&D, and R&D is their capital expenditure. A manufacturer designates CapEx to replace worn out equipment; Google designates R&D to replace worn out technology.
As far as I can tell, so far so good. Gmail continues to innovate a comparably Paleozoic product in e-mail and has become the single most indispensable tool in my life. I would even happily pay a reasonable monthly fee for its service, because I cannot imagine retreating to a desktop client with unorganized threads and an inflexible folder system. What else? Android has already leapfrogged the iPhone OS in market share and will soon swallow the Blackberry. YouTube is finally becoming a relevant revenue generator. Google Maps is ubiquitous and deservedly so because it's the fastest and most feature rich and most extensible. Chrome is evolving scarily fast, and if Seth Godin is right about standing out to early adopters such as myself as the path to marketing success, it will soon be right up there with Firefox and a decaying Internet Explorer brand.
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I am a value investor, but I cannot predict Google's future cash flows with any reliability. Why am I willing to invested in GOOG and blatantly flaunt the code? Because I AM sure of its future success. Instead of cash flows, I am willing to measure it by innovations, and in human history, especially in America, innovations inevitably lead to success, growth, and yes, finally cash flows.
