For the second year in a row, I got up extra early on a Saturday in May and tuned in to listen to the tag team duo of Buffett and Munger discuss topics galore at the Berkshire annual meeting (replay here). The Q&A session that often runs for several hours is a treasure trove of wisdom, on investing, politics and life in general, all with a touch of humor. I imagine that some of you may have been there live and some may have listened in like me - halfly paying attention with my bluetooth headset glued to my right ear and my two year old son in tow, going about my usual routine of cooking breakfast, chores and a walk outside. Many of the same questions from previous years were rehashed for sure but an unwavering adherence to his philosophy is partly what makes the Oracle so good at what he does. And drilling the same sound ideas into our heads probably is the only way that some of us will remember them and internalize them.
While I can't do the entire meeting justice here (there are plenty of articles and blogs that probably can and already have), there were some themes and topics that especially stood out to me. I'll cover the first one here and look to cover a few additional themes in subsequent weeks. As an aside, it's worth noting that the entire meeting was released as a podcast this year which was a week long treat for me to be able to listen back through the entire meeting a couple times.
A New Found Appreciation for Tech
“I think we were smart enough to figure out Google—those ads worked so much better in the early days than anything else—so I would say that we failed you there.”
The 2017 meeting was very similar to meetings of past in many ways but it was also very different in one key way. I heard the names of tech companies like Google (GOOG), Apple (AAPL), Amazon (AMZN) uttered numerous times and I heard words like cloud, artificial intelligence and self-driving cars mentioned more than once. This was the year of tech in Omaha. This was partly driven by recent moves to sell part of BRK's stake in IBM and buy a large position in Apple (AAPL). To say that Buffett has stayed away from tech in the past is an understatement. He has avoided it like the plague - noting for a long time that he didn't really understand it because it is out of his circle of competence. But something has changed in Buffett and we saw signs of this emerging in last year's meeting. In the 2016 meeting Buffett said, "The ideal business is one that requires no capital but still grows." He repeated this statement almost word for word this year - except it made a lot more sense in the context of his recent purchases of Apple - a company that designs beautiful technology products but doesn't touch manufacturing with a ten foot pole - i.e. it requires very little capital and churns out gobs of cash flow without much reinvestment.
And Buffett and Munger also went on to sing the praises of Google and Amazon. In the case of Google, they noted that they had the opportunity to understand that business very early on because Geico was paying $10 a click for Google search ads and it's a great business model when you can charge that amount without any incremental cost. Furthermore, the founders of Google had come to Buffett to invest shortly after the IPO but he passed without really digging in given his general aversion to tech.
And as it relates to Amazon, I would go so far as to say that Buffett and Munger may have a man crush on Jeff Bezos. I don't blame them. They praised Bezos' achievements in building two very successful but very different businesses (retail and Amazon Web Services) from a standing start. Buffett noted that he "always admired him as a business leader" but he was "too dumb to realize what was going to happen". Munger noted that they missed Amazon because it was hard- which makes sense as succeeding in retail is definitely no easy task. He recommended reading Bezos' first shareholder letter from 1997 (I have referenced it many a time) and his interview on Charlie Rose.
It's interesting when we break down this evolution in Munger and Buffett's philosophy but it's not surprising. They've always said that they avoid tech because it's not within their circle of competence but I never quite bought this. I'm sure railroads (BNSF) or payments (American Express) weren't in their circle of competence either until they took the time to really learn the industries and businesses. More likely, I think they believed the competitive advantages of technology companies weren't sustainable. And having been through the dotcom crash of the early 2000's, they were rightfully wary. But I think what they have come to appreciate is that many of today's tech companies aren't on the bleeding edge of technology. Rather, many of them are mature businesses with dominant market share in the verticals they occupy. And many of them aren't too dissimilar from other great companies in other industries- they make wonderful products and services for a very loyal consumer base and that loyalty affords them a high degree of pricing power. In fact, Buffett noted that he didn't really evaluate Apple as a tech company at all but as a consumer products company with a loyal/sticky customer base. In fact, he noted that he used the Scuttlebutt Method (Yes - I was elated!) in his evaluation - he went around Omaha asking his nieces and nephews about their devices to better understand their value to their loyal owners (smartphones are another appendage) and their loyalty to Apple (it's fervent). Apple device owners overwhelmingly upgrade to new Apple devices!
And so yes - these tech companies are not that different from other great companies. But they are different in one very big way that is super important. These tech companies are incredibly scalable - growing them doesn't require large reinvestments of capital - they reinvest little and generate very high returns on the capital they do invest. And it's very clear that Return on Invested Capital is a metric that Buffett cares a lot about. This very important metric was mentioned several times during the meeting in relation to new investments in airlines, their ownership of McLane (a distributor) and a few other times. Buffett noted that the world has changed considerably from the capital consumptive steel mills of Andrew Carnegie's day to the capital light cash generators that now dominate the economy and that it's likely to continue. He went on to comment that the top five companies by market cap which comprise $2.5 trillion of market value are all tech companies (Apple, Alphabet, Microsoft, Amazon and Facebook).
I think that Buffett's views on tech are pretty accurate. Many in the value investing world (Sequoia Fund) have owned companies like Google for some time - noting the scalability and durability. Where I might modestly depart from Buffett (have you no respect Raj!) is in the degree of capital intensity of these businesses. I agree that they are much lighter in capital requirements than old economy industrial businesses, but they are not completely capital deficient. Two things I would note here. 1) More and more, companies like Google, Facebook and Amazon are investing large sums (some is capitalized but some is operating leases) in building out data center infrastructure that they believe will provide them with competitive advantages. Now this can be done in an asset light way (by using Amazon web services) but the big players like Facebook and Google would never want the fox that is Amazon in the henhouse. 2) A lot of the investments these companies make in their product just aren't capitalized the way they are for traditional businesses. The investments run through the income statement because of traditional accounting rules around capitalization. Nonetheless, the investments (whether capitalized or expensed) that they make relative to the earning streams is much "lighter" as compared to more traditional non-tech businesses given the scalability of the business models.
Next up on themes from the 2017 Berkshire Annual Meeting: A little LUV for the Airlines