Since we’ve always been in technology our paths haven’t crossed much with firms like Berkshire Hathaway.Â They have long eschewed investments of a technology sort with the refrain that they focus on “businesses they can understand.”
Few would bother to argue with that stance.Â One isn’t likely to outperform by knowing less than others about an industry or an underlying business.Â Technology companies also have an extra high-octane component that has to do with the companies positioning and investor perception.Â Â There are often giant disparities between where two very similar companies trade from a valuation standpoint.Â It’s not unusual to see one company trading at 1x sales and 12x earnings with another at 5x or even 10x sales and over 50x earnings.Â These large gaps exist even when we normalize margins.Â Â Â Getting these differences right can be as important as understanding the fundamentals about the technology business itself.Â Yet another reason to avoid technology investing unless you have a real edge.
Something happened to the boys at Berkshire that we didn’t expect.Â They stumbled into the perception problem from another direction – options and derivatives.Â The first time this got reported and the stock tanked, we bought shares in $BRK for the very first time.Â They rapidly recovered their lost value and we sold due to the large gain in a very short period of time in a market that puts a premium on keeping dry powder around every day.
A few weeks later we read the Berkshire shareholder letter and immediately saw the problem.Â Warren Buffet and Charlie Munger certainly understand what they are doing and their newfound exposure to long-term options and derivatives looks like a good decision from a dollars and sense standpoint.Â However it’s put a cloud of doubt into the story and creates a risk that long-term core holders in the shares may decide that the company is no longer what they understood.
We’ve observed that options are a real blind spot for many people, no matter how smart they are.Â We spent a heated hour or two in the White Horse Tavern in NYC trying to explain them to a friend who had a PhD in physics to no avail.Â Â Since then we’ve worked with scores of analysts and found that many have a hard time getting even the most basic options contracts and stategies.Â There’s just something about them (like statistics or chemistry or drawing a horse) that blocks the mind.
Warren took great pains to fully explain their exposure in the shareholder letter and why large fluctuations in stated value and the balance sheet were not “real” in his sense of the word.Â Â The problem is the majority of his shareholders may never be able to fully understand and feel comfortable with the new story.
The real question for us is do they understand the valuation haircut they may have given $BRK thanks to this new facet of market perception?Â Unless the situation reverses itself the gains made from these new positions may not be enough to offset lower investor confidence in their asset value and investment approach.
[Research 2.0 has no position in $BRK at the time of this writing.]