Tech Stocks and Value Investing
To be very clear, I’m a fan of value investing. I think it’s wise to target stocks that seem underappreciated. I also think “value investing” causes a lot of people to miss out on valuable investments.
No one is opposed to finding value in their investments. You won’t find a financial manager or strategist who thinks “value” is a bad thing. Unfortunately, value investing has come to describe a specific investment technique, targeting stocks that seem to be trading below their value with a low price-to-earnings ratio. A lot of people, most famously Warren Buffett, have made gobs of money using this strategy over the years. In theory, it’s a good approach designed to help people target quality, affordable stocks.
Unfortunately, hardline subscribers to the value investing method tend to leave objectively valuable stocks out of their portfolios. By avoiding the priciest shares, you skip right past many of the stocks that have the best long-term value.
I’m a fan of Warren Buffet and have learned a lot about investing by following his career. However, as I developed my own strategies, I started to diverge from his teachings in a few different areas. Most notably, I don’t avoid expensive tech stocks. Recently, Buffett has made some moves that fall in line with my thinking, offering further proof that value investing isn’t the be all, end all technique some people make it out to be.
The Nuts and Bolts
To further define value investing, you have to look into the analysis. A value stock is one that people perceive as having a reduced price based on whatever conditions got it to that number. Typically short-term factors, such as oil prices, trade relations, and jobs data will influence the market and lead to certain stock prices falling below their intrinsic value.
Essentially, this is just Bargain Shopping 101. After Halloween, you can get great deals on candy. When apples are in season, you’ll pay less for them at the grocery store. When yet another streaming service eventually gets offered, the price of DVDs could take another hit.
A bargain, of course, doesn’t equal a good investment; you can get a bad product for a low price. That’s where the intrinsic value comes in. Whatever drives down the cost of shares, in theory, won’t keep them down. Value investors wait for a good company to take a price hit and then buy a stake in that business before it goes back up.
For Buffet, this system has worked wonders. For myself and my clients, value trading has brought in lots of money over the years. For everyone who uses value theory as a justification for avoiding pricey shares of excellent companies, this school of investing can potentially hold you back. A few reasons why:
Setting a Threshold
Depending on your investment capital, you might be very careful with the stocks you choose to buy. It’s always good to make informed decisions, but some people get so caught up in targeting undervalued shares they lose sight of the actual value. The beauty of a low asking price overshadows the intrinsic worth of a company and, while you might get some stock at a good price, you won’t position yourself to bring in much revenue. In short, don’t overvalue value while evaluating undervalued stocks. Got it?
Good Stocks Are Expensive
When the words “value” and “cheap” become interchangeable, you start to get in trouble. People new to investing find lots of appeal in stocks selling for under $20; you can buy more shares, you’ve got less to lose, and if they stock takes off you’ll get really rich. This works out roughly .000003% of the time.
The stocks you really want in your portfolio cost more. You might spend $2,000 just to get 20 shares. Of course, the amount you pay doesn’t contradict the philosophy of value investing. I’ve spent thousands and thousands of dollars in what would be considered value investing moves. Lots of people don’t feel comfortable spending that money, so they try to apply the value model to cheaper shares, thereby limiting the strength of their positions.
Some Prices Don’t Drop
If you’re waiting for Amazon or Apple or Google to fall into the acceptable price-to-earnings ratio for a value buy, make sure not to hold your breath. When you only target value stocks, you essentially rule out most of the heavy hitters. It’s not impossible to put together a lucrative portfolio without big-name stocks, but it certainly doesn’t hurt to have them in there.
The Tech Conundrum
This brings me to my main deviation from Buffett’s traditional stance on tech companies. He famously wrote them off, saying you can’t risk investing in companies and industries you don’t understand. I mostly agree with that theory, as you’re more likely to make a dumb move if you’re investing in businesses you can’t explain. However, you don’t have to know how to write code to see which tech enterprises are having unprecedented success.
Long-term investing is the best way to utilize the stock market. I don’t have to spend all day buying and selling shares because I know that holding good stocks for a few decades will yield much better returns than chasing short-term value. And, over that long haul, I’m very confident that tech is going to remain at the center of our industries.
Here are a few of the game-changing platforms sprouted from the seed of technology:
● Online marketplaces
● Streaming services
● Rideshare apps
● Social networks
These services have changed the way we go through our days. Online shopping essentially put an end to the American mall; Netflix and the like ended the reign of the video rental store; rideshare services flipped the taxi industry on its head, and so on and so on. From an investment standpoint, there’s no justification for ignoring these massive industrial shifts and the companies responsible.
Nevertheless, people stay away for two different reasons. First, per Buffett’s advice, they avoid buying shares of companies they don’t understand. To that I say, you don’t need to understand the daily routine of a Facebook engineer to know that the company interacts with billions of people every day, making it an incomparably powerful business.
The second reason people aren’t rushing to buy Bitcoin, Apple or Netflix stock is because of the value evaluation. In recent history, these stocks have rarely been undervalued, and waiting for their share price to drop is likely a waste of time. If you want a share of Bitcoin, you have to spend seven or eight or nine thousand dollars.
Combining a high buying price with a lack of understanding makes it hard for many investors to take the plunge. No one wants to spend $10,000 dollars buying 50 shares of Apple only to watch the stock drop by 50 points the next day. In a volatile market, that’s a possibility you have to consider; 300-point swings in the Dow can leave you reeling if you’re looking to make a short-term profit.
But that’s exactly why we’re in this for the long haul. As our economy shifts, changes and grows, the prices of different stocks will shift, change… and grow. The largest companies will have bad days and weeks, sometimes bad months and years, but as they adapt and recover you will see stock prices rise. You’ll get dividend payments and your retirement funds will increase.
10 years from now, you won’t bemoan buying a stock at $340 that your friend bought at $280. Instead, you’ll be happy you bought stake in a good company, got 10 year’s worth of dividends and have a valuable stock you can continue holding until its time to retire.
It’s easy to see why value traders stay away from tech stocks. In the 20 years since the internet took over the world, we’ve seen a lot of companies burst onto the scene only to fizzle out within a year. After Silicon Valley turned so many people into millionaires in the late 1990s, a lot of people lost their shirts trying to recreate that success. When it comes to retirement investing, no one wants to get burned.
However, there’s a stark difference between the get-rich-quick approach that happened in the wake of the tech boom and acknowledging the intrinsic value of a big company. Buying Google or Amazon stock right now isn’t some whimsical move that will make you rich overnight. Those stocks will just continue to grow until you forget what you paid originally and you’re overjoyed that you got in on the action.
In order to invest in the best, you have to think outside the value box from time to time. Recognize that some quality holdings might never be significantly undervalued. Some businesses will have high trading prices and low profit margins because so much capital is getting reinvested in expansion. A growing business makes a great addition to your portfolio, so putting too much importance on profit can really handicap your investing efforts.
With constant software updates and competitive startups launching every day, it will always be difficult to keep up with tech. That makes value investing a little difficult, but it doesn’t take away from the value of the industry itself.
Buffett Buys Amazon
I’m delighted to report that Mr. Buffett has stepped in to help prove my point. Flying directly in the face both value investing and avoiding tech stocks, Berkshire Hathaway recently bought a bunch of Amazon stock, one of the priciest shares an investor can buy. In the past, Buffett made it sound like Amazon was an opportunity missed, with the value scale being so tilted it wouldn’t be worth his investment. And yet here we are.
Why the change of heart? I haven’t spoken with Warren personally, but I can only speculate it’s that Amazon is a global institution with influence in virtually every industry. The reach of the business dwarfs that of any other company, and it’s so deeply entrenched in e-commerce that extended growth looks like the only option. The company continues investing in itself and those investments continue to pay off.
At $1,800 a share, a lot of people think Amazon stock is too rich for their blood. In five years, that price will be higher and those who buy it now will be sitting pretty. Sure, Berkshire Hathaway could have made trillions of dollars buying Amazon at $15 per share in 2002, but that has no bearing on the value of the company now. Buffett is too smart to leave Amazon out of his portfolio just because he didn’t buy at the optimal moment; the Oracle of Omaha knows there’s still plenty of money to be made off the stock, despite the asking price.
In early 2019, some pundits took shots at Buffett for his purchase of Apple (he bought it back in 2017). Threats of a trade war and a lot of market activity caused the stock to fall pretty sharply, and Buffett was an easy target because of his previous admission of not understanding tech stocks. Since then, Apple has gained ground, even with a handful of rocky patches.
And still, who wouldn’t want to own Apple stock? Buying price aside, iPhones are still the most popular gadget on the planet and the company is thriving. As the stock price jumps around due to a number of outside influences, we have to remember that the company hasn’t lost its footing, and to imply that buying Apple was a bad decision misses the point entirely.
With so much focus on beating the market, people forget that the market itself provides a winning strategy. A century of continued growth and recovery from times of hardship show the resiliency of the market and our industries. The people who make the most money off the stock market are those who trust it to deliver returns, not the people who think they can beat the system.
If you can buy a quality stock at a good price, do it. If you notice a company trading well below its competitors and intrinsic value, swoop up those shares. As you look for those opportunities, don’t forget that the goal is sustained, long-term growth. While you’re searching for value now, you don’t want to miss out on the companies that will be really valuable later.