“If we can’t find things within our circle of competence, we don’t expand the circle. We’ll wait.”
For decades, Warren Buffett has ignored technology stocks, often repeating his comment about how they don’t fit into his circle of competence.
And yet the investor revealed yesterday a $10 billion stake in IBM, the “Big Blue” of tech.
In the 1990’s, Warren Buffett was derided for ignoring the huge boom in technology companies. Of course, Warren had the last laugh as his net worth continued to grow long after the Internet boom went bust.
So has Buffett finally gone off the deep end and abandoned his circle of competence?
Hardly. If anything, IBM has simply gone from providing technology hardware to becoming one of the largest non-financial service providers around. That’s
the kind of business Buffett is famous for buying into.
It was certainly no surprise to find out that Buffett increased his stake in Wells Fargo (WFC). Financial companies thrive on recurring-revenue, whether in the form of monthly fees, annual performance bonuses, or transaction fees.
Indeed, the best advantage that big-tech names like IBM have today is their recurring-revenue model. Rather than sell one product to a customer once, a company sells a host of services over time. Rather than a one-time sale, the company continually gets paid. That builds customer loyalty over time.
And, when a company needs to scale back, they look at future expenditures before current expenditures. An IBM customer facing some tough times might halt plans to expand their business, but they’ll think twice before ending their service contract.
Investors today can emulate Buffett with a better selection of big-name tech stocks. On Friday, I mentioned Cisco (CSCO) as one candidate.
As part of its restructuring, Cisco has expanded its service offerings to gain recurring revenues.
But there are also growing, cash-rich companies like Intel (INTC) and Qualcomm (QCOM). Intel is the dominant player in computer processors by a wide margin. Qualcomm derives revenues from leasing out patents on its technology, another way to achieve recurring revenue.
All three trade at slightly better financial ratios than what Buffett paid. Despite the recent market rally, big-cap technology companies remain a stunning bargain.
These large-cap tech stocks make the kind of products that are easy to fit in anyone’s circle of competence. The world needs processors, chips and routers. The value for this infrastructure runs into billions of dollars of spending each year.
That’s in stark contrast to tech companies that have captured the spotlight and reek of another Internet boom. Stick with big-cap tech while it’s still undervalued.
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