Why Buffett Finally Bought Into Tech

By James Brumley | November 17, 2011 AAA

When Warren Buffett bites off a big piece of a technology name for the Berkshire Hathaway (NYSE:BRK.A) portfolio, then clearly times are changing. (To know more about Warren Buffet, read Warren Buffet: How He Does It.)

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For decades, the world's most legendary investor has avoided technology stocks, saying they're too unpredictable. That's what makes last quarter's decision to buy a big chunk of International Business Machines (NYSE:IBM) such an interesting one - it's so unlike him. All told, the investment fund bought $10.7 billion, or 5%, worth of Big Blue.

Were it just IBM, investors could likely chalk it up to an unusual situation that only Buffett saw. It wasn't just IBM though. The fund added other technology picks like General Dynamics (NYSE:GD), Intel Corporation (Nasdaq:INTC), and DirecTV (Nasdaq:DTV) during the third quarter of 2011. Granted, it wasn't the same-sized position as IBM's was, but they were technology stock additions nonetheless, and something new for Mr. Buffett.

Value investing fans everywhere, somewhat shell-shocked, are asking the same question ... why? The answer to the question isn't as odd as one might imagine though. (For additional reading, check out The Value Investor's Handbook.)

The "New" Technology Sector
Have you taken a good, close look at IBM lately? As Mr. Buffett pointed out in his post-release comments, IBM is still a technology company, but it's not predominantly a hardware company any more. More than anything, it's a services company, which for tech names can often mean reliable, recurring revenue.

Just to illustrate the power of recurring revenue, IBM has increased earnings every year since 2003, and every quarter (on a year-over-year basis) since 2004, sailing through the 2008 recession as if it never happened. And, though a forward-looking P/E around 12.7 isn't rock-bottom bargain pricing for IBM shares, it's certainly not your typical tech valuation for a consistently profitable name.

With the exception of Intel, the other technology stocks Warren Buffett picked up in bulk for Berkshire last quarter operate with the same strategy. Though DirecTV is a revolving door of coming and going subscribers, the business is built on the regular collection of monthly subscription fees from the customers it has that month (retention is as big of a challenge as acquisition).

General Dynamics - as a government contractor - doesn't pull in the exact same revenue each and every quarter, but it keeps a steady stream of contracts going at all times, and wins new ones in the meantime. Its earnings, and earnings growth, have been surprisingly consistent since 2003 as well, with only a small hit in 2007 and 2009, and then the move to record earnings anyway in 2011.

So how does Intel fit into that mold? It doesn't, at least not on the recurring revenue front. With the stock trading at only 9.9 times 2012's anticipated earnings, though, the "value" argument still holds up.

The Bottom Line
There's been some speculation that these picks are less Buffett's and more Todd Combs' - Berkshire's newest manager. And, that may well be the case. However, it wouldn't be impossible to believe that Buffett could have pulled the trigger on these trades. They're tech names to be sure, but they're the staples of the technology sector, which is something that has always appealed to Buffett.

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At the time of writing, James Brumley did not own shares in any of the companies mentioned in this article.

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