It’s commonly believed that Warren Buffett doesn’t buy tech stocks.
But that’s not true.
In fact, Buffett’s largest personal investment (outside of Berkshire) for many years was into a start-up tech business.
In 1960, Buffett put 20% of his entire net worth (!) into Data Documents. This was a start-up computer punch-card business founded a year earlier by two friends, Wayne Eaves and John Cleary.
Eaves and Cleary knew a lot about the computer business, which, at the time, was dominated by IBM. Specifically, they figured out that printing the “data documents” – the punch cards that were needed to program huge mainframe computers – was the most profitable business that IBM owned. Eaves and Cleary thought they could buy the presses needed to make the cards and then undercut IBM on price. But the machines were expensive – $78,000 each – and they needed capital to grow. So, they called Buffett and offered him a 16% equity interest in exchange for the capital needed to buy one press.
Over time, Buffett would invest around $1 million into the business. And, over 18 years, he earned a 33% annual return on the investment! While we don’t know precisely how much Buffett made from this investment, a reasonable estimate is $100 million. (If the $1 million compounded at 33% over 18 years, he could have made $169.5 million.)
I learned this from a video that surfaced recently (hat tip: Kevin Carpenter) of Buffett’s biographer, Alice Schroeder. Schroeder was the insurance analyst at Morgan Stanley who covered Berkshire and would later spend six years writing Buffett’s definitive biography, The Snowball.
In 2008 she gave a talk at a value-investing conference at the University of Virginia. And in this talk Schroeder explained an amazing secret about Buffett’s approach to tech investing.
First and foremost? Buffett’s maxim: Never lose money.
But how in the world can you invest in a venture tech company without putting capital at risk? You don’t!
When first approached about the opportunity (in 1959) Buffett turned his friends down.
Schroeder explained:
“The first step in Warren’s investing process is always to say, ‘What are the odds that this business could be subject to any kind of catastrophe risk that could make it just fail?’ If there is any chance that any significant amount of his capital could be subject to catastrophe risk, he just stops thinking. No. And he won’t go there. It’s backwards [to] the way that most people invest because most people find an interesting idea, they figure out the math, they look at the financials, they do a projection, and then at the end they ask themselves, ‘Okay, what could go wrong?’ Warren starts with what could go wrong. Here, he said a start-up business competing with IBM could fail. Nope. Sorry. And he didn’t think another thing about it.”
Happily, Eaves and Cleary didn’t fail. After a year in business, their start-up was growing fast. With the risk of catastrophic failure off the table, Buffett was interested. And so in 1960, when they needed capital to expand, Buffett said: Send over the financials.
Schroeder continued:
“They explained to Buffett that they were turning their capital over 7x a year. A Carroll press cost $78,000 [and] every time they run a set of cards through it and turn their capital over, they are making over $11,000. So basically their gross profit a year on a press is enough to buy another printing press. At this point, Warren is very interested. Their net profit margins are 40%. It’s like the most profitable business that he’s ever had the opportunity to invest in.”
Buffett then studied all of the company’s figures, quarter by quarter. He also researched similar information he could find on their competitors. But, interestingly, unlike just about every other investor I know, he didn’t bother coming up with an earnings forecast model. Instead, he approached his investment decision on a binary basis – just yes or no. And he made his decision based on his belief that the company would surely earn at least a 15% return on his capital.
In other words, Buffett wasn’t expecting anything spectacular from this investment. Instead, he wanted to make sure, first that he wasn’t going to lose anything, and second, that it was overwhelmingly likely to provide an adequate return.
Schroeder explained that’s the same way Buffett made every investment decision she ever saw him make.
“The way he thought about it was really simple. It was a one-step decision. He looked at historical data and then he had this generic return that he wants on everything. It was a very easy decision for him — and he relied totally on historical figures with no projections. I think that that’s a really interesting way to look at it because I saw him do it over and over in different investments.”
Interestingly, that’s the same way I’ve gone about making my best investments – like my recommendations of Anheuser-Busch in 2006, of Hershey (HSY) and NVR (NVR) in 2007, of Microsoft (MSFT) in 2012, of W.R. Berkley (WRB) in 2012; and more recently, of Domino’s Pizza (DPZ). These businesses were virtually certain to provide us with a very adequate return, and it was virtually impossible for us to lose money in these companies.
And look what happened after those recommendations in 2006 and 2007 – the worst economic disaster of our entire lifetime! But despite these enormous challenges, those investments continued to operate profitably throughout the entire period – even NVR, the homebuilder!
I don’t know if I can convince any of you, but I’m more convinced than ever that the best way to invest is always the easiest and the safest. Just buy the world’s greatest businesses, don’t pay too much, and wait. That formula works, no matter what else is happening in the world.
Looking at our recommended list today, I note there are plenty of these kinds of opportunities: Deere & Co. (DE), Diageo (DEO), Philip Morris International (PM), Nike (NKE), and Hershey, for example.
You can make investing hard. But it doesn’t have to be.
There’s a video of Schroeder’s discussion of Buffett’s investing approach here.
Porter Stansberry
Stevenson, MD
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