The Inevitables

Value investors tend to shy away from technology companies.  There are typically two primary reasons for this.  First, technology can sometimes be difficult to understand.  For example, Nvidia is a technology company that designs graphic processing units.  These units can be used in graphics on PCs, potentially artificial intelligence and autonomous driving.  However, I have absolutely no clue whether another company is working on a better product that will leap ahead of Nvidia in any or all of these areas.  Also, I can’t reliability explain to my 10-year old why Nvidia’s current products are better than the ones on the market.  

This drawback may be a personal one, but I do think it will apply in various ways in all investors’ experiences.  If you just don’t understand what makes a company great, there is no possibility you will be able to see how or when it begins to lose that “greatness.”  

The second reason for avoiding technology companies is the landscape seems to change so fast.  I could list hundreds of companies that are less than a decade old that have already peaked and since essentially be shut down.  This rapid obsolescence in the technology field is worrisome among investors, for good reason.  

I think it is a big mistake to avoid technology as an investor.  This is something I have slowly learned over the years.

If you are at the top of the tech heap, the past year has been a bonanza for your stock’s valuation.

1 yr returns
S&P 15%
Facebook 29%
Google 35%
Amazon 38%
Microsoft 40%
Apple 57%
Netflix 65%
Tencent 59%

The NY Times had an interesting article a few weeks back titled,
Tech’s Frightful Five.  

The article and corresponding stock returns make it seems like these companies are inevitable.  They are destined to dominate their respective industries and probably collide with each other quite frequently as they attempt to suck up as much value into their own ecosystem.  

Technology companies are valued right now based on their inevitability.  I don’t disagree at this current stage, although I could make passing arguments why each might be susceptible to stiff competition in the future.    

I don’t think it is important to point out specifically what problems Facebook could encounter, but to understand whether you are in a position to spot those problems before they have a major impact on the value of the company.

Let’s go back in time to Blackberry and Apple.  Blackberry dominance was on full display in the business world.  As a young associate at a “Big Law” firm in NYC, I saw vividly how attached people were to their Blackberry phones.  The technology that Blackberry brought to the palm of your hand was revolutionary (If you are interested in the rise and fall of Blackberry, Losing the Signal is truly a great book).  However, within 6 months, my wife had the new iPhone and we were traveling.  She was driving and I was trying to guide her with my Blackberry.  We got lost.  I used her iPhone and we made to our final destination with ease. It was so obvious, the Blackberry was a great power email machine, but was basically a brick in comparison to the iPhone for virtually any other task.  I couldn’t describe the inner workings of the technology, but being close to the consumer, in this case, my wife and myself, was very important.  I could easily see how the technology from Blackberry was being leapfrogged.    

Some technology companies that I have researched recently, Workday, Hubspot, and Atlassian are all valued as if they are going to be big winners in their respective markets.  This could easily be the case.  However, if we imagine these companies as Blackberry, I don’t see myself as being close enough to the consumer in any of those cases to easily tell if some other company is leapfrogging their software.  

I am trying to make three different points here, so I will summarize for my own benefit.  

  1. I think value investors need to stop thinking all technology companies are scary.  Technology is here to stay and I do think it is pulling a lot of value away from incumbents.  
  2. Understanding the inner workings of a technology is different from being close to the consumer, such that you can see the value it provides to the consumer and if another company or technology comes along to provide greater value to the consumer.  
  3. The requirement to be that close to the consumer requires continual evaluation of the companies you own, which implicitly encourages a concentrated portfolio.  


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