Everyone and their mom has been talking about digitally transforming industry and society at large for decades now, and it is perhaps not for no reason. The benefits to going online include the potential to reach globally, grow exponentially and scale at near zero marginal cost, as well as benefit from low labour costs through remote work or simply robotic process automation software.
From the side of acquirers, another innate advantage of a tech-enabled business that harnesses the power of the internet compared to a traditional offline brick and mortar shop, is that it is far more easily assessed from afar. Travelling to a geographic location on the map to physically inspect processes and machinery vs performing due diligence on a tech stack online via APIs and virtual data rooms is night and day.
To crystalize this new era of business and investments brought on by the world wide web, consider a famous vignette. To those unfamiliar with the story of Berkshire Hathaway and Warren Buffett’s investment strategy, it really is worth taking a minute to appreciate the take-away lessons from the performance and underlying investment strategies employed during this +65-year period.
Warren started out his career first as an investment salesman and then as a securities analyst working for another investor. The partners of that corporation had experienced the bank runs of Black Tuesday first-hand and as a consequence based their decision-making process around the cigar butt analogy.
This strategy entailed investing in under-priced businesses, i.e. companies with stocks trading below the value of the assets on their balance sheet. The idea was that even a cigar-butt left on the sidewalk has one good puff left in it.
It would be an understatement to say that this rubbed off on Warren as he wholeheartedly adopted and executed the cigar-butt investing for the first two decades of his investing career after going independent.
He would go on to dub this strategy “fair businesses at wonderful prices” and it worked well in the 60s and 70s back when the companies had much lower P/E and P/B ratios. Technology was less advanced then compared to today which made it easier to find overlooked stock by trawling through paper filings.
A few decades later, Warren would change his investment strategy and slogan to “wonderful businesses at fair prices” after joining forces with Charlie Munger under the Berkshire Hathaway corporate umbrella. This evolution in his investment approach benefitted him immensely. But one thing didn’t change fast enough… and that was his stance on technology companies.
Right from the beginning of his days as an independent investor he would write to his limited partners that he would never invest in tech businesses because he didn’t “understand them”. His motto was investing in companies so strong that they could be run by a “ham sandwich”!
With the benefit of hindsight, one could argue his policy caused him and his LPs to miss out on several big tech companies that came out of Silicon Valley way back in the day.
In a lot of ways, his anti-tech stance served him well for a long time as his focus on industries like insurance, railways and publishing ultimately grew his company north of $100B. That said, there is no telling how big his fortune could have been had he had a different attitude towards the ventures leading the computer and internet revolution. It wasn’t until the 21st century that he softened up to the idea when he invested in IBM.
This investment would ironically take a big hit but it led him down the right path to the single biggest payday for Berkshire Hathaway in absolute money terms. Five years after buying Apple stock in 2016, Warren can boast about $87.5B in unrealised returns.
The tale of Warren Buffett paints a clear picture of how the opportunity landscape shifts as times change. As a young gun he was right to invest in the industries he did; Geico, Disney, the Washington Post etc., but when society started to go from analog to digital and offline to online, Warren missed the boat. And by the time he tried to catch up, he bet on the wrong horse: the archaic tech grandfather to the present-day industry innovators.
“Software is eating the world” as the venture capitalists, Andreessen Horowitz, over at a16z famously said about the status quo. Everything indicates that the future is going to be more technology-enabled, not less, which for anyone looking to grow their wealth and capitalise on opportunities means that investing in software and hardware over brick and mortar is the way forward.
This brings us to the second take-away from the story of Warren, which is the high-risk/high-reward relation of investing in technology-harnessing businesses.
The innovation cycles are much faster and shorter, which as a consequence makes it harder to stay competitive in the long run. Even so, network effects create winners and take all rewards for actors that manage to build a brand and grow a loyal customer base through product and/or marketing.
This is not an argument against operating or investing in online businesses but rather a reason to hedge bets. Founders can do this by selling a piece of their business to get some cash off the table while staying invested for the long run to realise any future upside. Similarly, investors can hedge their bet by buying into multiple internet ventures either as a minority or majority stakeholder.
Useful references: Acquired podcast, Snowball, Cigar Butt Investing, Partial Buyouts
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