Legendary value investor Warren Buffett is notorious for avoiding investments in the technology sector. The main reason he steers clear of such stocks is because he's loathed to invest in any business he doesn't acutely understand. Even during the height of the dot.com boom of the late 1990s, Buffett shied away from even the hottest internet plays. When asked about specifics, Buffett articulated two chief reasons for his reluctance to dive into the tech pool. This article takes a closer look at those reasons.
- Value investment guru Warren Buffett is known for his reluctance to invest in the technology sector.
- Buffett steered clear of dot.com stocks, even during the height of the tech boom in the late 1990s.
- Buffett believes most tech plays lack "economic moats," which are sets of competitive advantages allowing companies to prosper in the long run, including patentable products and high barriers to entry for competitors.
- Buffett is also reluctant to invest in tech names because their valuations are inherently unstable.
- Buffett has made rare exceptions, taking positions in Apple Inc. and IBM.
The Economic Moat
First and foremost, according to Buffett, technology companies lack "economic moats," a term he coined in 1999 to describe a collection of competitive advantages companies must have in order to remain profitable over the long haul. Moats may comprise a multitude of factors, including patents on products that are essential to a particular service, as well as high barriers to entry for competitive interests. Without these advantages firmly in place, a company may struggle to grow its market share in a crowded field.
Explained Buffett: "The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors."
Hard to Pick Winners
The second reason is Buffett is leery of tech stocks, is because he believes it's hard to reliably choose winners. Furthermore, it's a challenging prospect to determine if valuations will hold strong--even for seemingly attractive stocks. His view is supported by research, which shows that even thriving dot.com plays can suddenly experience sharply declining valuations. In other words, the tech landscape is intrinsically unpredictable and unstable.
Despite his staunch anti-tech posture, Buffett has made a few rare exceptions, where he took the technology plunge. But even in these situations, only the largest and most well-established companies caught his attention. Case in point: In May 2018, Buffett's investment company, Berkshire Hathaway, owned 165.3 million shares in Apple, valued at approximately $42.5 billion. This investment ostensibly replaced the company's 2011 tech sector investment when it bought 64 million shares of IBM stock, which were subsequently sold throughout 2017 and 2018.
(For related reading, see "How Warren Buffett Made Berkshire Hathaway.")
Economic moats are named after the protective water barriers that protected medieval castles from attackers.