The “Too Hard” Pile

Investors using DCF analysis to make concentrated investments in companies selling below estimated present value must be careful to avoid (1) companies they don’t fully understand and (2) companies with uncertain prospects over the next 10 to 20 years. When Charlie Munger and Warren Buffett look for investments to concentrate in, they put companies in the “too hard” pile unless they meet both these criteria. Very few companies make the cut, and Buffett is willing to wait a long time for the right prospect at a fair price. Citing Ted Williams, Buffett says he gets his results by only swinging at fat pitches in his “happy zone” — otherwise he keeps the bat on his shoulder.

I think the too hard concept — and the importance of patience — is often forgotten or ignored by investors trying to imitate Buffett’s concentrated approach. Impatient for returns, these investors apply DCF analysis, and estimate future earnings, even though they don’t understand the business and therefore can’t assess earnings resilience and competitive threats. An investor may also understand the current business but still be uncertain of future prospects because the company lacks a unique, defensible strategy — a competitive moat — or because the product or industry changes too fast due to competition or new technologies. Despite these issues, many investors project long term earnings, incorporate these figures into present value estimates, and make concentrated investments in companies that should be placed in the too hard pile. Lacking patience, they swing at bad pitches. Mistakes like these can devastate the value of a concentrated portfolio. 

You could argue that Buffett’s best investments have generally been in companies with the simplest businesses and the clearest long term prospects. Coca-Cola, See’s Candies, and GEICO come to mind — all simple businesses with wide competitive moats and very long runways of profitable, predictable demand (especially when Buffett made his original purchases). Buffett has encountered trouble when the business is more complicated, the competitive moat isn’t obvious, and long term demand is less clear: IBM, Oracle, U.S. Air, Solomon Brothers, and even Wells Fargo (with its more recent troubles) quickly come to mind.

The author is not an investment advisor or CFA and readers should consult an investment advisor before buying or selling any publicly traded stock. The views expressed in this article are the author's personal opinions and should not be construed as investment advice.

Ability to Partner as Competitive Advantage

When it comes to services, Apple is in a better position to partner than any other tech company. It's difficult for Facebook or Google to closely partner with other service providers because other providers steal user attention and hurt ad sales. Horizontal service companies trying to be on all devices depend on the user's choice of their services over other services. 

A vertically integrated player like Apple doesn't care if its services dominate. Apple wants its services to be attractive and promote ecosystem stickiness, but Apple doesn't need its services to dominate to drive profits. That's because Apple's profitability is driven not by services, but by a three part mix of hardware, OS, and ecosystem. No single element of this mix dominates, and Apple can have a great ecosystem with in-house services/apps like contacts, calendar, notes, maps, and iWork, and third party services/apps provided by IBM, Microsoft, Twitter, Google, Facebook, and thousands of independent developers.

If you don't need your services to dominate or even be profitable to prosper, then you're free to partner with any service company you want. And that's what Apple does, partnering with IBM for enterprise software, Microsoft for its Office suite, and even Google for maps. These kinds of partnerships are difficult if you have a horizontal business model and you need your services to dominate to drive subscriptions or ad sales (e.g., Google search, Facebook, Evernote, etc.).

In a 2007, D5 interview Steve Jobs said he admired Microsoft's ability to partner with other companies. Apple now seems to address this issue by partnering as convenient on services while still owning the key hardware, manufacturing, and OS technologies and IP. See post titled Why Apple "Outsources" Applications and Services.

The author owns stock shares of Apple.