Author: Rocco Huang
Covestor model: Tortoise and the Hare
Disclosure: Long ACN, AAPL
Since I am such a big fan of Warren Buffett, when Berkshire’s most recent 10-Q revealed that the company had spent nearly $7 billion in unnamed stocks in the “Commercial, Industrial, and Other” category, I couldn’t help but making some wild guesses. I guessed UPS or FedEx. It turned out that Buffett bought IBM.
Of course, I was not surprised at all that my guesses were off. Otherwise, I would have been a billionaire myself. Most embarrassing of all was that I put my foot in my mouth by saying that
[w]e can probably rule out any IT service companies such as Accenture plc (ACN) no matter how cheap or how dominant they are, because we know that Mr. Buffett prefers businesses that he can understand and that he expects to remain more or less the same 20 years from now. He doesn’t like his investment to be tied to technological changes.
IBM is in IT services.
The Tortoise Portfolio continues to own Accenture plc (ACN). I am glad that my hero Warren Buffett now also invests in the IT Services space. However, let me also explain why I still like ACN better than IBM at their current prices.
(1) Accenture is even less exposed to technological changes than IBM, because it simply implements whatever third-party technologies are currently standard. In contrast, despite being described as an IT service company in recent media coverage, I believe that about half of IBM’s value is driven by its proprietary middleware/software business lines (e.g. Websphere, Information Management, Lotus, Tivoli, Rational).
I am sure Buffett is well aware of this, and I am also sure that he is smarter than I am, and therefore I am still trying very hard to understand his reasoning behind this investment in what I believe to be a software company.
(2) Accenture is cheaper based on my valuation system. Nothing beats bargains. In “Wal-Mart: Dead Stock Walking” I explain why buying at a bargain price can hide a lot of sins, while overpaying can cost you a decade of return. In the case of Accenture vs. IBM, my valuation system actually shows that IBM is a bargain too, but Accenture is an additional 10-20% cheaper than IBM.
Many of you who closely follow Buffett’s words and actions may point out that Warren Buffett would not care about a 20% difference, because (1) 20% is well within the error band of any forecast, and (2) it is better to pay a fair price for a wonderful company. Fair enough. My defense is that: (1) Accenture is a wonderful company too., and (2) I am a very thrifty person and I care about 20%. I believe that if I watch the pennies, then the dollars will take care of themselves.
Will I buy IBM in the future? Definitely possible, at the right price. I am very patient and patience is an investor’s best friend. I spend a lot of time watching IBM, and Louis Gerstner’s “Who Says Elephant Can’t Dance?” is one of my favorite management books. But emotional attachment should never be part of an investment process. The price has to be right.
(3) Small investors like us have many advantages over large institutional investors because we are not affected by many constraints they face. Berkshire nowadays looks more like a Dow Jones Industrial Average index fund, because megacap stocks seem to be the only space where it can airdrop an elephant (pun intended) without causing a huge splash.
Interestingly, in “Nobody buys Apple anymore. It’s too crowded” I also explain why large institutional investors may be the reason why many megacap stocks are currently undervalued. The basic idea is that most institutional investors are allowed to overweight a stock by only several percentage points, and therefore it is hard for them to overweight Apple in a meaningful way even if they are very optimistic. Apple is so dominant in the benchmark that if a mutual fund invests only 3% in Apple it is actually underweighting it.
In such situations, sometimes there are only two catalysts for value realization: (1) Earnings grow over time and the same stock price goes from just cheap to ridiculously cheap, or (2) unconventional large investors (e.g. Berkshire), unconstrained by the restrictions discussed above, jump into the pool.
