Whether investors should exclude technology stocks?

Whether investors should exclude technology stocks?

2016-09-17 Li Chen                                            

 (Li Chen investment memorandum 20160708)


Chinese Way Buffett Investing Club (CWBIC) had an internal discussion among its members on whether or not they should invest in technology stocks.  The discussion was a brainstorm with many insightful views being expressed.
We have learned investing from Buffett for many years.  The core ideas are more or less the same.  An industry which has a simple and stable business model possessing great prospects is certainly a first choice for investing and can even be considered for a concentrated portfolio. I have invested up to eighty percent of my fund in the industries of consumption, health and finance, with the rest twenty percent in energy and wisdom industries.
Today’s debating was concentrating on whether our investment should be totally exclusive of "technology stocks".
First of all, I want point out the observed facts that in their later stage of investing life, Buffett and Munger have not repelled "technology stocks" and even heavily invested in IBM, as one of their four core permanent holdings. Buffett wanted to buy more BYD’s shares, but Chuanfu Wang was not willing to sell more of them. Otherwise Buffett would probably own a lot more stakes in BYD. The reason for their purchase of technology stocks can be very simple.  On one hand, the growth in traditional industries is quite sluggish in the United States, and in the meantime, the market is also overpriced. This phenomenon cannot be more accommodating for Buffett’s ever bulging wallet.  There is a need to expand the area of investment. On the other hand, science and technology industry have flourished with bright prospects. Apple, Google and Amazon all have their market value surpass that of Exxon Mobil, Wal-Mart and other giants in traditional industries.
Masayoshi Son, Lei Zhang, and Lu Li have achieved great successes in their investment in "technology stocks" such as Alibaba, Tencent and BYD, respectively. Yongping Duan had invested ninety percent of his capital in Apple, after his earlier successes with NetEase and other technology stock investments.    
I think their success is neither accidental nor due to good luck.  Rather it is the fruitful result of opportunities being offered to them in the era, combined with their individual effort and competence.

It does not serve serious purpose by merely grouping investments into technology stocks and non-technology stocks based on their appearances.  Munger has divided investment more scientifically into three categories, which are can-invest, can-not-invest, and it-is-difficult-to-understand categories. Certain technology stocks can fall into the can-invest category, while some non-technology stocks can actually be in the can-not-invest category.
Here is a short story about our investments in Maotai and Guangyuyuan.  Both were shunned by investors when their business prospects were dimmed a few years ago.  Jianmin brother has wisely coined the term "distressed prince".  This is just like while nobody was interested in tilling on barren lands, contention is high for a tillable one.  After the stock prices have risen today, people are feeling increasingly optimistic on them.  But then when we went to Chengdu for a liquor fair, there were widespread pessimistic view, even among people from the liquor industry.   There were dozens of us going to the fair, but I was the only one keeping buying lowly priced Maotai shares.  That made me appear a bit odd for them.   But I firmly believed that the difficulties Maotai facing were just temporary.  A harsh winter for business operators was just a spring time for investors in Maotai’s case. The situation for Guangyuyuan was similar.  When the market value of Guangyuyuan was merely between four and five billion yuans, we started investing in it heavily. Very few people understood what we were doing then.  They believed we violated the concept of value investing and Buffett’s investing principles.  But we did think, in essence, we were in full compliance with Buffett’s investment philosophy despite on the surface it was showing otherwise.
Aside from widely accepted industry classification, in my opinion, Maotai, Guangyuyuan are actually businesses with very high technology content.  Competitors have founded it difficult to break into its formulation, techniques and ecological process. Guochun Wang said liquor making at bottom is microbial technology.  It is essentially hard-to-crack high technology. Buffett's four stock picking filters do not necessarily exclude technology stocks, provided that they meet the following criteria:  Their business can be understood. They have a moat. A good management is in place, and finally they have a margin of safety.

So you need to analyze specific issues case by case, and overly generalization across the board has no meaningful benefit.   Technology companies can just fall within your circle of competence.  To be investable, they need to have a sky-city like bright future, together with a wide moat and high barrier of entry, and embedded with a super strong team culture, or as aggressive as a North American pike as Munger once cited, or armed with strong endless innovating ability, etc. When the market price is reasonable versus their valuation, they can be a long-term investment, though it may not necessarily be a permanent position, for your portfolio.  Buffett also regretted not having investing in a set of pharmaceutical companies.  Pharmaceutical companies in the west are also technical companies in nature.  I think in investing we should have the courage to think in contrast with the popular view, and thus we can not to be rigid in our thinking.  Munger have made an exception to invest in BYD.  It is an example of analyzing specific issues boldly, breaking the original investment model.  On the basis of adventurous investment in BYD made by Munger, I proposed the original analytical framework. It is hoped to break Buffett’s classical analytical framework.
However, my personal recommendation is to exclude the following technology stocks for investment:  They are difficult to understand. The technology changes quickly and can easily be undermined.  Their innovation is disruptive with a low barrier to entry or to form a necessary moat. They are not eligible for patent protection.  For others, once you can understand them, and they meet the selection criteria, you can invest in them.
In addition, on the surface Tencent is a technology stock. But in fact it has low technology content. It can be claimed that Tencent has slowed down the speed of Internet.
The technical barrier for Corun’s NiMH battery is very high.  It is accumulation of years of developing efforts.  The pace of technological upgrading is relatively slow.  They company ranked as top three in the world, backed up with Toyota strategic liaison. The establishment of the CHS assembly platform has widen the moat for Corun’s ecosystem.  It is a small-cap with tremendous prospects. Corun is in full compliance with Buffett's stock selection criteria.
Apple, with the world’s largest market capitalization, is also a technology company.  Although the product line is being updated very quickly, but its strong corporate culture has widen the moat for its ecosystem.  Its smart phones become synonymous with high-quality products.  It is of interest that for Buffett himself Apple does not comply with his stock selection criteria because he does not know what the future will hold for Apple decades later, but his follower Yongping Duan believed that Apple fully comply with Buffett's stock selection criteria, and thus has invested in Apple.  It becomes even more interesting now that Buffett's own successor has also recently bought Apple’s stocks in large quantities.
So I am against merely going with all the premises that most people have without looking deep through the surface. It should depend on the specific company whether you can understand or whether it meets the stock selection criteria.  Otherwise it can easily be prejudiced, and our thinking can be solidified in certain doctrines. In fact, Buffett repeatedly broke his own set of doctrines, such as avoiding technology stocks, or companies with wheels, or asset-heavy companies, or cyclical companies.
In short, as long as companies meet the criteria of a compounding machine, they can be long-term investments. Under certain special circumstances, they can also be classified as unconventional investments.
Also, the circle of competence, based on one’s knowledge and experience, is decided to a large degree by investor’s preference.  After following the basic principles of a sound investment theory, the investing approach will eventually be personalized. If not, we will become an investment machine of old-fashioned dogma, and eventually we will be replaced by investing robots armed with artificial intelligence.
I personally focus more on investing in great enterprises typical of a compounding machine, but neither do I reject technology sector.  The utmost reason is that I have emptied myself, including the bondage of Buffett’s thought, and quietly and thoroughly perceived that: in the Internet age, commercial ecological system has undergone great changes, and it also gives birth to some greatest business models with a new business ecosystem moat. Although from the stability and life cycle points of view, these business models may seem to fall short of liquor, or Chinese traditional medicine and other traditional industries.  But the sky-city like bright future, beyond the constraints from production elements to achieve exponential growth, with a high return on capital and a strong ecosystem moat, makes up for the lack of these traits typical in a traditional and thus more stable industry.  Tencent is a representative of those outstanding enterprises.
Buffett is 86 years old this year and Munger is 92 years old. But our young people, on the basis of continuation of Buffett’s thought, should sense the pulse of the time and take advantage of the opportunities.  Having a good grasp of classic investment opportunities, we should have the courage to innovate and embrace a new era of business models which will bring great investment opportunities.
Pines are loaded with heavy snow, but their trunks stand straight. Investing is never a safe sailing.  Benjamin Graham, father of value investing, was almost bankrupt during the Great Depression. But he created the concept of "margin of safety" (later was called value investing) in the crisis.  He won the game and became a saint arrived in heaven from hell. Investment is an endless marathon.  We need to engage in lifelong learning and evolve continuously.  We will perfect our skills and have a sense of fulfillment in such endeavors.  Therefore, we will not give up on the ultimate pursuit of the "investment art".

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Whether investors should exclude technology stocks?


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