2010-11-04

The Problem With Investing in High-Tech

As a high-tech engineer and a value investor, I'm often caught in the middle of what might be seen as a conflict between the two: should value investors shun high-tech?

Hardcore value investors often quote Warren Buffett's reasons for not investing in technology companies: Buffett admits he does not understand the world of high technology well enough to be sure of which companies will still dominate their core area in 10, 20, or even 30 years from now. Despite being friends with and admirer of Bill Gates, Buffett has never invested in Microsoft nor any other high-tech company. The closest he got to high-tech was investing in Chinese fuel-cell maker BYD.

The Case in Favor of High-Tech

Predicting dominant position in 20 or 30 years is not really what value investing is all about. There's plenty of money to be made by companies that don't fully dominate their markets. After all, not every company can be a dominant player in its market, and there are way more profitable companies than markets out there.

Moreover, being the dominant company in the next 10 to 30 years is probably asking too much of tech, where many of its fields did not even exist 5 or 10 years ago. Fortunes can be made in a short span of time in technology, since consumer preferences change quickly, specially for online services (think social networking, search, micro-blogging platforms, etc).

Also, high-tech is where a lot of attention is. And following attention, many times is reward. And attention should be there in case of tech. With simple changes millions of lives can be changed (typically for the better, but not always).

Think of how people found addresses until recently: physical maps. Then printed maps online, GPS devices and now phones and watches can guide you from Timbuktu to Kathmandu.

Or how many expecting mothers couldn't see if their babies had any problems before they were born because ultrasound imaging technology didn't exist.

The Case Against High-Tech

That said, there are real criticisms for investing in tech that are not related to the difficulty in predicting dominant positions in the future.

The problems are many.

Need for constant innovation. How can one ever be sure that the next product to come out of Apple will be a blockbuster? Motorola all but disappeared from the market after its success with the Razor phone. One day the Apple's iPhone is all the rage, the next day, Google's Android is outselling it. High-tech companies need to invest a lot of effort into innovative new products to keep people buying new ones. And that entails spending money on research and development and also retaining talented employees. Compare Apple or Nokia with Coca-cola and WD-40. Which ones haven't changed their product in 20 years?

High-tech companies are typically young and without a solid track record. That's just the nature of their businesses. While this is not true for some more mature companies such as Microsoft and Intel, others are still not exactly on Value Line's 10-year index either.

Most tech companies don't pay dividends. And the few that do typically don't pay meaningful dividends. They keep the cash around for making deals, acquiring smaller upcoming companies and defending their positions, which can typically be attacked very quickly by faster, more nimble smaller competitors.

Repeat business. While not all tech companies are single-sale business, some are. How many times can someone buy a new video game, laptop, cellphone, etc? Having repeat customers can often yield superb results. Think Starbucks coffees and Gillette razors. Warren Buffett once said about his investment in Gillette that he takes comfort in knowing that 2.5 billion males will be shaving in the morning.

Too much attention. As discussed before tech draws a lot of attention and it's harder to find inefficiencies and mispriced securities when everyone is dissecting these companies. Value investing has a lot to do with discovering hidden gems in balance sheets.

Conclusion

All told, I love innovation and the occasional high-tech gadget. And I do reserve a small pool of money to invest in promising new technologies and solid high-tech companies when they fit my investing criteria.

But when it comes to investing the bulk of my money, it goes into companies that are simple, have been established for long, draw less attention, don't require a lot of innovation to maintain and, of course, pay out lots of dividends.

Disclosures: I own shares of PG, KO, GOOG at the time of writing.