For decades legendary investor Warren Buffett refused to buy technology stocks. He missed the huge bull market in the mid to late 1990’s and people repeatedly questioned his decision in light of the obvious tech revolution. After the dot-com bubble burst he looked brilliant, for a while at least. Interestingly, Buffett avoided tech stocks not due to some core issue such as high valuation, but instead because he simply did not understand the industry. As someone who popularized the term “circle of competence,” his lack of deep understanding of the sector meant that he did not feel like he could analyze these companies well enough to make an investment.
Then in 2011 something changed. Buffett started to amass a huge stake in his first technology investment; IBM. Close followers of the Oracle of Omaha, especially those who knew a decent amount about the tech sector, were doubly shocked at hearing this news. Not only had Buffett violated his decades old rule, but he had chosen for his first tech investment a giant that was widely seen within the industry as being a symbol of “old tech” – one that was only going to be marginalized by newer companies and technologies.
Fast forward six years and Berkshire Hathaway’s 2016 annual report shows that Buffett’s firm owns a staggering 81.2 million shares of IBM. Since purchasing 63.9 million in 2011, he has increased his position by another 27% in subsequent years. That stake was worth $13.5 billion as of year-end 2016. The annual report also discloses his total cost basis in IBM; $13.8 billion. Given a cumulative loss since the initial purchase in 2011, it is hard to argue that Buffett should have ventured into an industry he admittedly knew little about.
While the IBM story is old news for Buffett watchers, I think it is noteworthy given his recent comments on CNBC two weeks ago that during the month of January he acquired 76 million shares of Apple. Buffett admitted in the interview that he did not have an iPhone and that he queried his young family members to see how they like Apple products.
Apple shares have been on a tear in 2017, in part due to news that Buffett was buying.
I have to wonder if this second step into the tech world will share any of the same characteristics of the IBM investment.
Perhaps the bigger point is this idea of one’s circle of competence when it comes to investing. When I look back at my own career managing money it is obvious that my batting average is far higher within industries I am more familiar, and vice versa. There are multiple instances where I have lost money on energy exploration stocks and early stage biotech stocks, to name a couple of areas outside my circle. While I have never instituted a rule that prohibits me from buying stocks in certain sectors, over the years I have definitely allocated more capital to sectors I know best.
That decision does not always help me, especially when investment managers are compared with very diversified indexes. For instance, since the election of President Trump, companies focused on manufacturing, construction, and infrastructure have performed very well. I own very few of these types of names, and in some cases none at all. That lack of exposure to a strongly performing group has materially impacted my short term performance.
My hope is that my clients would rather me avoid sectors I don’t understand well (even if that means poor relative short-term results), as opposed to feeling like I need to have exposure to a little bit of everything in case sectors outside my circle of competence happen to perform well for a while. If I am going to be judged on mt ability to pick individual securities, I may as well stack the odds more in my favor, right?
Regardless, I can’t help but believe that such a strategy makes the most sense, even if it does not always pay off in spades. And if I had to guess, that probably goes for most other (both professional and amateur) investors too.
As for Apple stock, while I continue to hold some both personally and on behalf of clients, the recent run-up to $140 per share probably means that future returns will be more muted, as the stock now trades for roughly 15 times annual free cash flow per share.
Full Disclosure: Long shares of Apple at the time of writing, but positions may change at any time