Tuesday, July 12, 2016

Predictability and technology

I often look for quotes from Warren Buffett or Charlie Munger when I'm trying to think about how a business model for a company I'm looking at may develop, and how those possibilities relate to my downside risk. Comparing the business model with what I look for in downside risk on that potential investment is why I've essentially filtered my prospective ideas into four categories to help guide the time I spend on potential ideas. I discussed the categories in THIS article a few years ago, but they've progressed quite a bit since then, so I need to update that article at some point. 

But finding wisdom from Buffett and Munger to help in the thinking and filtering process has been quite valuable, and Peter Bevelin's latest book has been of great use in helping to find such wisdom. The most recent example being the excerpt below from Warren Buffett's 2009 letter which I think is worth thinking about whenever one is looking at a technology-related business:
Charlie and I avoid businesses whose futures we can’t evaluate, no matter how exciting their products may be. In the past, it required no brilliance for people to foresee the fabulous growth that awaited such industries as autos (in 1910), aircraft (in 1930) and television sets (in 1950). But the future then also included competitive dynamics that would decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding. 
Just because Charlie and I can clearly see dramatic growth ahead for an industry does not mean we can judge what its profit margins and returns on capital will be as a host of competitors battle for supremacy.
I think one of the biggest mistakes investors make is to underestimate the competitive landscape, and as I mentioned in the Key Checklist Items post, this includes businesses and entrepreneurs that aren’t even competitors yet, which is especially relevant when looking at technology companies. Predicting a growing industry is far different, and easier, than predicting how that growth will translate into a profit margin and return on capital for an individual company (a point made by Mr. Buffett in the quote above). 

Over the last couple of years, I've posted more links related to technology and venture capital than I had previously. Part of this is because I'm a believer that the way in which technology and the internet will change business models and competitive advantages going forward is still in its early stages, and also because I think there is a lot to learn from that world about management teams and business cultures. From an investment standpoint, these types of businesses are generally more unpredictable. But if one can look at smaller public companies and wait for the fat pitch, it's occasionally possible to find one at a value price where one's downside is not dependent on having to predict the unpredictable.

And given the winner-take-all nature of the internet, if one is able to recognize a true moat in a business within an industry destined to become much larger (e.g. Google in search, Amazon in e-commerce, etc.), especially if one can find that business relatively early and pay a good-to-fair price, then it is possible for one to practice Charlie Munger's desired method of finding a few great companies and then sitting on your ass, even among businesses where technological change plays a large role. Determining what a good-to-fair price is, of course, the art, challenge and opportunity in investing.