In the world of value investing, it is rare that big tech stocks ever enter into the conversation.
Tech is, to some degree, considered to be out of bounds, mostly because it is difficult to understand how intellectual property factors on the balance sheet and the volatility that investing in these companies tends to involve. A lack of tangible assets on the balance sheet and ghosts of the early 1990's tech bubble only add to value investors' caution
Warren Buffett (Trades, Portfolio), the most famous value investor of all time, has historically stayed away from the sector for these reasons, as well as the fact that he struggles to understand how the industry works, which is a very valid reason for those of us not involved in Silicon Valley.
However, he has recently changed his tune, first with the acquisition of IBM (IBM, Financial) for Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) and then with the substantial buying of Apple (AAPL, Financial), which is now by far his most substantial position.
Time to reconsider tech?
In my view, this marks a change of opinions. Tech is a substantial part of the world we live in, and that fact is not going to change anytime soon.
What has changed recently, however, is the established nature of these businesses. One of the reasons why Buffett initially liked IBM is because of its long history of changing with the times and producing returns for investors. Companies like Apple and Amazon (AMZN, Financial) are still babies compared to IBM, but they are building their history, showcasing their strengths for future investors who may be uncertain about the sector.
To put it another way, these tech companies have now moved from being risky startups or "tech companies" to plain old "companies" in much the same way Coca-Cola (KO, Financial) and Wells Fargo (WFC, Financial) have become everyday businesses that are unlikely to vanish overnight, thanks to their established customer base and reputation.
Indeed, one thing to consider about tech companies is the tremendous amount of money they are investing in their future growth. Netflix (NFLX, Financial), for example, is spending billions of dollars developing its own content, which is costing the company. However, while the business might be hemorrhaging cash today, this investment in future growth will pay off over the next 10 to 20 years, which is precisely the sort of timeframe value investors are interested in.
The same can be said for Google's parent Alphabet (GOOGL, Financial) and Amazon. Both of these businesses are investing billions in building out their products and services and establishing a wide margin of safety around their business. These results will only become clear over the next five to 10 years.
Alphabet and Amazon have only become what they are today thanks to investments made five or 10 years ago. To be able to make the most of these opportunities, you need to have a long-term outlook, which is one of the key traits of value investors.
Time to buy?
Add this all together and it is easy to arrive at the conclusion that, after recent declines, value investors might be attracted to the likes of Apple and Alphabet (avoiding Facebook for all its PR issues).
Shares in Alphabet are only trading at a forward price-earnings ratio of 24.5 today, with earnings per share expected to grow by 26% this year and 17% for 2019.
This might seem like a high price to pay for a company, but considering the fact that the business has been compounding book value per share at 15% per annum for the past six years with a 15.1% return on capital employed, 25 times forward earnings is not that dear at all. In the words of Charlie Munger:
“If you buy a business just because it’s undervalued, then you have to worry about selling it when it reaches its intrinsic value. That’s hard. But if you can buy a few great companies, then you can sit on your ass. That’s a good thing.”
Meanwhile, shares in Apple are currently trading at a forward price-earnings of 14.9 with earnings per share growth of 24% predicted. The company has already returned an estimated $221 billion to investors over the past five years.
Disclosure: The author owns no share mentioned.
