Until very recently, Warren Buffett (Trades, Portfolio) tended to avoid tech stocks. The reason he always gave for doing so was that he did not understand the sector, and he never wants to be involved in an industry that he does not understand because if you go down this route, you can very quickly end up out of your depth.
The Oracle of Omaha has been criticized for taking this approach many times, particularly at the turn of the century when internet stocks were all the rage.
I like reading through the Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) letters to investors and annual meeting transcripts at this time because it gives me fascinating insight into the way Warren Buffett (Trades, Portfolio) thinks and his mindset in times of market excess.
Buffett on tech
Back in 1995, at the Berkshire Hathaway annual meeting, one shareholder asked Buffett if he had any interest in getting into tech stocks and how tech would fit into Berkshire's overall investment strategy.
Buffett replied by saying:
"We try not to get into things that we don’t understand. And if we’re going to lose your money, we want to be able to come before you, you know, next year and tell you we lost your money because we thought this and it turned out to be that."
Interestingly, he then went on to talk about how investing in the tech sector would have complied with Benjamin Graham's principles.
He concluded that Graham's principles of value investing are "perfectly valid" when applied to tech companies and just because Berkshire Hathaway doesn't invest in the sector doesn't mean that other investors should avoid it altogether as well.
The Berkshire Hathaway chairman went on to explain that it all comes down to how much you understand about a particular sector:
"My guess is that if Bill Gates (Trades, Portfolio) were thinking about some company in an arena that he understood and that I didn’t understand, he would apply much the same way of thinking about the investment decision that I would. He would just understand the business.
I might think I understand Coca-Cola or Gillette. And he may have —he may have the ability to understand a lot of other businesses that seems as clear to him as Coke or Gillette would seem to me.
I think once he identified those, he would apply pretty much the same yardsticks in deciding how to act."
Continuing the example, Buffett says that when Bill Gates (Trades, Portfolio) evaluates a potential investment, he might "have a margin of safety principle that might be a little different because there's essentially more risk in a high tech company," but he would still use a margin of safety principle when evaluating a potential investment. He would have a "mathematical risk of loss" in his mind, look at the company as a business, not a stock and not buy it on borrowed money.
It is not often that we see Buffett comparing Graham's principles of investing in other sectors, so this insight is particularly fascinating. What the Oracle of Omaha seems to be saying is that Graham's principles apply to investors of all experience levels, in all sectors -- no matter their background.
Graham's framework
Graham didn't just invent value investing, he also proposed a framework for fundamental investing, and this is what we see here.
Graham taught a whole generation of investors that investing in stocks is not just about picking lottery tickets; it is about investing in businesses at attractive prices with a small risk of permanent capital impairment.
Whether it be consumer goods, technology, biotech or resources, the same principles are easily transferable and continue to apply.
Disclosure: The author owns shares of Berkshire Hathaway.
