Sunday, 13 May 2012

Facebook does not tickle Warren Buffett's fancy

Warren Buffett famously steers clear of companies he doesn't understand.  Now with an incredible amount of pre-IPO hype surrounding Facebook, he still isn't biting.

It has little to do with whether Facebook is a good prospect or not (in the tech world, especially websites, determining long term value is incredibly difficult anyway due to the short attention spans and fad-seeking culture that's commonplace).  It has everything to do with the fact that he doesn't understand Facebook and how it generates its cashflow.  Online tech is not Berkshire Hathaway's specialty and they aren't going to participate in a renaissance (possibly second bubble) of the dotcom industry.  Buffet's right hand man Charlie Munger didn't mince his words: "I don't invest in what I don't understand, and I don't want to understand Facebook."

Buffett himself said, "We never buy into an offering. The idea that something coming out...that's being offered with significant commissions, all kinds of publicity, the seller electing the time to sell, is going to be the best single investment that I can make in the world among thousands of choices is mathematically impossible."

Buffett's "missed opportunities"
A commentator rightly pointed out that Buffett missed out on Microsoft and Google - companies that significantly grew since listing on the stock exchange.  But Buffett also missed out on companies like InfoSpace - which dropped from $1,305 to $22 in one year - and numerous others.  Sure, even someone mildly tech savvy would have probably been able to rank Google as a better buy than InfoSpace, but Buffett could not for whatever reason and he acknowledges this by staying out of the tech industry (mainstay IBM being the only exception.)  He comes from another era and only invests in companies whose business models he can easily and quickly explain.

Warren Buffett likes businesses that provide a high probability of maintaining and growing cash flows.  Facebook is the in-thing today, but nobody, absolutely nobody knows how the online landscape will change in 5 years.  On the other hand you know with near certainty that businesses like Coca Cola, General Electric and Procter & Gamble Co. are very likely to grow if not maintain their profits over the next decade.  As luck would have it Buffett has a significant stake in all these companies.  Berkshire Hathaway's portfolio is built on salt of the earth sectors like rail, insurance, food and so on.  Things change at a more comprehensible rate in these industries: with tech the scene can get turned upside down in months.

Based on this, one can't help but feel that the popular $100 billion valuation of Facebook is possibly inflated and was thrown out to the media as bait by a Facebook influenced campaign to generate "interest" (read hype) before they list.  They might exceed that $100 billion value in years to come, but in the industry they're in they are just as likely to lose ground to a myriad of new competitors (Pinterest the most prominent this year) and fade from that $100 billion valuation.  There's an equal chance of things going either way.

Understanding trumps hype
When you listen to hype and jump on a bandwagon without bothering to question too deeply as to why you're doing it (other than to make a quick buck), you could very well pull it off on occasion.  But there is no way you can earn a sustained living this way.  You will never become prolific.

The lesson Warren Buffett has been hammering for decades to people is that you need to pivot your investing strategy and decisions around you and your strengths; not around what financial advisors or markets dictate.  Ascertain the sort of sectors your brain is wired to understand, then seek out the best companies in these sectors.  You can't keep every single listed company on your radar, much less have exposure to every sector.

How many people with no understanding of Facebook will be queuing to buy its shares?  You wouldn't vote for a presidential candidate just because he is popular with your friends, so why do this with your money?

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