Apple stock has gone down nearly 10% or lost close to $100 Billion between 2nd and 5th Nov 2018.
It is apparent that the same mistake is being repeated in Mr. Buffet’s Apple investment as he did when he invested in IBM in 2011. To understand why value investors like Buffet cannot get technology stocks mostly, we must appreciate that Innovation is the key to technology companies.
Sanjeev Sharma, author of the award-winning book ‘5 Core Methods of Innovation’ and contributing writer at SeekingAlpha had written on SeekingAlpha stocktalk on 25th Oct 2011 that IBM stock would go down, right after Mr. Warren Buffet announced he is buying IBM.
Here is an excerpt from his book ‘5 Core Methods of Innovation’ published in 2013, that explains why Value investors who are only looking at financial statements and stable products do mistakes in evaluating technology companies
“Book Excerpt: 5 Core Methods of Innovation”
VALUE INVESTING vs THE POWER OF PASSION
There are two distinct schools of thought in business management education in the United States. The first one encourages investing capital in risky-ventures and thus encourages startup ventures and venture capital Industry. Graduates from Stanford business school usually are known for starting up and leading major technology-based companies. The second school of thought encourages Value investing and encourages identifying companies which have stable financial track records, give regular dividends but are still available for a reasonable or ‘value’ price. Capital preservation is considered more important than growth opportunities for the sake of minimizing risk to the invested capital. Columbia business school is a leader in the Value investing principles. Mr Warren Buffet is the most famous alumnus of Columbia business school and has built enormous wealth identifying good stable but undervalued companies. Value investors by nature avoid risk-taking and are looking for safe bets. Established business practices are what lures them. Value investors make investments in traditional companies with long track records of profitability. The investment is done at a price which is considered lower and below what the fundamental analysis of the company would suggest. Value investors may not be making as much money in years of intense volatility where the stock market has favored a particular Industry, but they are expected to make consistent and reasonable returns for a long time. Their investments also lose money during periods of recession but at a lower rate than the markets’ favorites of previous years. To search for such companies, value investors look for companies with Low P/E (price to earnings ratio) ratios, consistent EPS (earnings per share) and regular and consistent high dividends. Value investors also prefer that the companies are leaders in their particular industries and that these industries have consistent high Earnings for a long time. Mr. Warren Buffet defines this concept as “moats around the company” which means that the company must have something that gives it an advantage over competition for a long time. Further, Mr. Warren Buffet has stated that “When a good manager meets a bad Industry, the Industry usually wins”. In other words, if you invest in an Industry which is going downhill, the chances of the company being profitable for a long time are low. Unfortunately, Value investors fail to understand the power of Passion in business. If money was invested in Apple’s stock in 2004, it would have grown fifty times by 2012. However, many famous value investors missed the opportunity and did not invest in Apple.
Many entrepreneurs enter highly competitive or sometimes commodity businesses but still dramatically grow their companies due to their sheer passion for the business. When Amazon.com started selling books, it was written off by many value investors as they felt that just almost anybody can open a competing website selling books. As explained in an earlier chapter, Amazon.com created an eco-system of customer service thereby making it a default one-stop choice for all internet based purchase. Amazon.com now sells a very large variety of products like electronics, shoes, garments and sports equipment. Amazon.com sells the products directly and also allows other vendors to sell through its website and compete with each other. Amazon.com has also entered services business and is a strong force in the cloud computing space.Amazon.com has been able to give a personal touch to its customers where customers feel that they would be “taken care” of by Amazon. The comfort level of customers of Amazon.com is so good that it was able to pre-sell a large number of its Kindle Fire product, before it was launched in November 2011. Customers were ready to purchase a $199 product without ever touching or feeling it, and took the word of Amazon on face value.
Similarly, Apple Inc in 2000 was almost a bankrupt organization. But Steve Jobs grew it to be larger than Microsoft in only a decade. All the products which Steve jobs created like iPod, iPad, iPhone etc. were created with leading-edge technologies which were available to other companies also. But, Steve Jobs with his passion was able to create new products at a faster pace and market them ahead of the competition. An iPod was the first successful digital based music player which replaced the CD players of the 90s and Sony Walkman of the 80s. Apple’s iPhone was the first mobile phone product utilizing the technology of a multi-touch screen. Similarly, an iPad was the first successful touchscreen digital pad. There were other companies which utilized similar technologies before Apple, but none could give an eco-system of marketing, technology, and ergonomics to be successful. The concept of Starbucks was only about selling coffee. It was a simple idea and there were tens of thousands of companies in the United States which could have emulated his model and grown a chain of retail coffee stores. However, except ’Seattle’s Best Coffee’, none of the other companies could grow like Starbucks. The Starbucks gives an ambiance of business environment and comfort. The ambiance of Starbucks includes an impressive interior-decoration, music, sofa sets, WI-FI connections for internet, business newspapers and smart salespersons wearing impressive uniforms. This ambiance adds to the customer’s feeling of luxury of choosing from a large variety of coffee drinks. The ambiance of Starbucks makes it ideal for many people to meet for short Business meetings at an affordable price. The high price of Starbucks makes it appealing for people to carry the coffee cup as an icon of status symbol. In order to maximize its profits and give uniform experience in its stores, Starbucks does not give franchises but owns all its retail outlets and keeps the employees on payroll offering them long-term career opportunities. Starbucks has created an ecosystem giving an optimum customer experience.
When Sam Walton was growing Walmart, he gave an offer to Mr. Warren Buffet to invest in it. However, Mr. Warren Buffet, being a value investor did not see any value in this retail business. He saw it as another retail store company and retail businesses were supposed to be low margin businesses with intense competition. Mr. Buffet could not appreciate the power of passion of Sam Walton. Sam Walton was a very aggressive business person and decided to utilize unconventional strategies to grow Walmart. Walmart utilized scales of economy and supply chain to bring the lowest price products to the US consumer. Walmart created giant stores where the consumer could enter knowing that he can purchase almost anything he needs in his home at the lowest price available in the market. Walmart also decided to grow first in rural areas rather than big cities thus establishing the clear lead over other competitors by taking advantage as a first mover. Walmart became the largest American company at one point and Mr. Warren Buffet considers not investing in Walmart as one of his biggest mistakes.
Purchase the book from Amazon.com