In an old letter to shareholders of Berkshire Hathaway, Warren Buffett offered his opinion that tech stocks made poor candidates for long-term investments because:
“A business that must deal with fast-moving technology is not going to lend itself to reliable evaluations of its long-term economics. Did we foresee thirty years ago what would transpire in the television-manufacturing or computer industries? Of course not. Nor did most investors and corporate managers who enthusiastically entered those industries. Why, then, should Charlie and I now think we can predict the future of other rapidly evolving businesses?”
It is a correct observation that the price you decide to pay for a stock is determined, in large part, by your estimation of the corporation’s future cash flows.
However, I would modify Buffett’s ideas about the fast-changing nature of the tech industry to note that corporations with high cash balances insulate themselves from the traditional vicissitudes of shifts in tech demand.
Specifically, I have in mind the five American corporations with the highest cash balances, which all come from the tech sector: (1) Apple with $215 billion, (2) Microsoft with $102 billion, (3) Alphabet with $73 billion, (4) Cisco with $60 billion, and (5) Oracle with $52 billion. The figures are current as of May 2016. This is an astounding amount of cash concentrated in the tech sector.
And I offer to you that these five corporations have a lesser risk profile that substantially mitigates the concerns about tech investing that Buffett references.
If you thought about buying IBM stock in 1968, it was earning $871 million. It was on track to become America’s first corporation to make a billion dolllars in profit in a single year. But here is the thing: It only had $47 million in cash on its books. It was one of the three largest corporations in the world based on market cap at the time, but it was carrying a cash position devoid of excess. The cash position at IBM wasn’t even as high as a month’s worth of profit. Therefore, it would be fair to conclude that any deterioration in IBM’s core business model would be a cause of nearly irreparable harm for the IBM shareholders of 1968.
But that is not the case with Apple, Microsoft, Alphabet, Cisco, and Oracle. They have so much cash that they can buy a market entrant position that follows the changing business landscape in tech. I don’t know what the source of tech profits will be in twenty years, but it is not inconceivable to suggest that these five companies have the ability to make a trillion dollars in acquisitions to maintain a relevant position in the industry. Basically, Facebook can go through its corporate life purchasing Instagrams, and Alphabet can go through its corporate life adding Youtubes to complement its search engine and ad servicing.
If you continue to profane tech investing, that is understandable. You can get very rich over a 25+ year time frame putting your money into Colgate or Hershey. Toothpaste and chocolate don’t require any managerial brilliance to sustain profits. However, I do argue that Apple, Microsoft, Alphabet, Cisco, and Oracle have a substantially lessened risk profile that make them ill-fitted for inclusion in Buffett’s general observations about tech industry investing. This is because they can offset any deterioration in demand for their core products by making acquisitions of companies riding the future waves. Fat stacks of cash enable these companies to be perpetual players.
This is not to suggest that I consider these five stocks buys at their current valuations. This article isn’t about that. Instead, I want you to consider the role that enormous cash loads will play in protecting the shareholders of these corporations during the future ebbs and flows in the industry. I think high cash balances dramatically dampens the long-term risk profile of these five.
Originally posted 2016-11-30 07:16:00.