- Benjamin Graham
Being contrarian isn’t easy. When the markets and the media are telling you that you are wrong time and time again, the color red and the cries of the crowd can cause your stomach to turn while emotions and fear counterbalance your analysis; in these trying times, the value investor, through a firm balance of humility and conviction, must remember that in the long run, the underlying value of a business will be reflected by a company’s stock price.
In his 1992 letter to shareholders, Warren Buffett (NYSE:BRK.B)(BRK.B) provided a solid mental framework for investors when he said the following about accounting for stock options:
“The most egregious case of let's-not-face-up-to-reality behavior by executives and accountants has occurred in the world of stock options. In Berkshire's 1985 annual report, I laid out my opinions about the use and misuse of options. But even when options are structured properly, they are accounted for in ways that make no sense. The lack of logic is not accidental: For decades, much of the business world has waged war against accounting rule makers, trying to keep the costs of stock options from being reflected in the profits of the corporations that issue them.
Typically, executives have argued that options are hard to value and that therefore their costs should be ignored. At other times managers have said that assigning a cost to options would injure small start-up businesses. Sometimes they have even solemnly declared that "out-of-the-money" options (those with an exercise price equal to or above the current market price) have no value when they are issued…
It seems to me that the realities of stock options can be summarized quite simply: If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And, if expenses shouldn't go into the calculation of earnings, where in the world should they go?”
There’s beauty in such simple (and flawless) logic. As Buffett noted in the 1998 letter, “A few years ago we asked three questions in these pages to which we have not yet received an answer.”
MY THREE QUESTIONS
Microsoft (MSFT) has been in the cross-fire as of late, and the main talking point is “The Death of the PC.” While this conclusion spits in the face of estimates from firms like Gartner and IDC (which predict global PC shipments will cross 500 million per annum in a few years, from roughly 350 million today), it’s interesting to look at this proclamation in addition to other talking points.
In a recent article, I discussed what I view as the goal for Windows 8, saying the following: “I think the rationale is clear as day – for all intents and purposes, Microsoft doesn’t need to worry about the PC market: Windows 8 will sell on computers and in a big way, regardless of its perception among techies (when I say big, I mean in comparison to any non-MSFT alternative). Microsoft is pushing this OS on consumers in the hope that the lure of familiarity (over time) and connectivity among devices will be enough to lure their faithful desktop base of more than 1 billion people into the world of smartphones and tablets (where the OS has received accolades) – and in my mind, this is all that matters.”
What amazes me is that when I read about Windows 8 from the same crowd predicting the death of the PC, they generally conclude the following: Windows 8 will be an attractive operating system on things like smartphones and tablets, but will be an utter failure on desktops (PCs). I’ve read these articles for weeks on end, and still can’t circle the square. As a result, I have three simple questions that I would like to have answered by anyone who can understand such rationale:
1. Is the PC dead? If you believe yes, please define what dead means in terms of PC shipments in the next couple of years (do they mean flat lined, or disappearing completely)?
2. If it is dead, what would be the smartest thing for Microsoft to do in their attempt to transfer their PC base of more than 1 billion PCs to the world of tablets and smartphones, where they have failed to gain traction?
3. If the PC will in fact remain relevant (which it would need to be for the Win8 desktop launch to even matter), and consumers wholly reject the Windows 8 operating system on the desktop, which OS will the vast majority of consumers and enterprises revert to? A look at Microsoft’s operating results during the launch of Vista may be instructive when answering this question.
I would happily change my investment thesis on Microsoft if there were answers to these questions (as a whole) that suggested something contrary to what I put forward in my recent value contest submission; yet in dozens of articles about this product launch and the future of Windows, I’ve yet to hear these seemingly apparent questions discussed a single time.
I think the crowd that is simultaneously calling for the death of the PC and the failure of Windows 8 should spend a few minutes thinking about what this would mean – if they did, I think they might have a bit clearer view on the strategy currently being pursued by the boys in Redmond.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, "Patience followed by pretty aggressive conduct."
I run a concentrated portfolio, with a handful of positions accounting for the majority of my equity holdings (currently two). From the perspective of a businessman, I believe this is adequate diversification.