Learn the Lesson Silicon Valley Taught Warren Buffett

In my monthly investment newsletter, Smart Money Masters, I research and analyze the investment philosophies of many of the world’s top investors.

A common theme runs through investors as diverse as activist investor Bill Ackman, Warren Buffett-acolyte Mohnish Pabrai and contrarian David Einhorn. Each calls himself a “value investor” and cites Graham and Dodd’s 1934 classic “Security Analysis” as the book that has most influenced their investment style.

So, what makes value investing so attractive to the world’s leading investors?

First, value investing offers the intellectual purity of objective financial analysis by focusing on a stock’s intrinsic value. Second, it allows investors to hold themselves above the distracting din of daily stock market fluctuations.

If the price of a stock goes down, you’re not wrong. It is just that the market doesn’t “get it.”

And by buying more, you get to show the world how smart you are.

Standing on the opposite side of the investment spectrum are growth investors. These folks invest in promises of wealth generated by new products, new business models and new paradigms. They make money when “this time (really) is different.”

Fans of Graham and Dodd dismiss growth investing as a strategy that invests in pie-in-the-sky story stocks that rarely pan out. You don’t need to look farther than the internet mania of the late 1990s and the housing bubbles to see how bets on a glorious, but undefined, future can go wrong.

Still, I think the singular focus on the Graham & Dodd value framework offers an incomplete picture. I was surprised to learn that the “Sage of Omaha” has come around to this view, as well.

Silicon Valley vs. Omaha: Andreessen vs. Buffett

Marc Andreessen is a Silicon Valley icon.

Andreessen co-created Mosaic, the first internet browser in the early 1990s. He also co-founded Netscape, which made the World Wide Web accessible to the global population.

Today, Andreessen is a venture capitalist in Silicon Valley. As a fellow investor, Andreessen has studied Warren Buffett’s investment philosophy closely.

His conclusion? He and Buffett are wired in opposite ways.

According to Andreessen, the secret to Buffett’s success is that he bets against change.

Buffett’s investment strategy relies on the insight that consumers will continue to buy hot dogs and ketchup — The Kraft Heinz Company (KHC) — and drink Coke — (The Coca-Cola Company (KO) — every day.

Buffett believes that consistent profits generated by established business models trump story stocks over the long run.

The contrast with Andreessen could not be greater.

From his perch on Sand Hill Road in Palo Alto, California, Andreessen’s goal is to identify and invest in paradigm-shifting ideas that will change the world. By definition, these ideas are new.

Silicon Valley’s most successful investments, Alphabet/Google (GOOGL), Facebook (FB), Twitter (TWTR) or Uber (private), barely existed a decade ago. In contrast, by investing in railroads, machinery and big banks, Buffett invests the same way he did when he started in the late 1950s.

Despite creating massive value for Berkshire Hathaway (BRK-B) shareholders over the past 50+ years, Warren Buffett has never created or financed anything that has changed the world.

Andreessen has confessed that every time he hears a story about a Buffett investment like See’s Candies or Coca-Cola or Gillette, he wants to find the new technology that would put these dinosaurs out of business.

You see the contrast in how Buffett and Andreessen view mistakes.

When Buffett makes a mistake, it’s because something changes that he didn’t expect.

When Andreessen makes a mistake, it’s because something didn’t change the way he expected it to.

Buffett’s Mea Culpa

The four most dangerous words in investment are “this time it’s different.”

During the dotcom boom, Buffet stuck to his guns and refused to abandon his time-tested, value-driven strategy.

Today, Buffett appears to have changed his tune.

To his credit, Buffett has acknowledged that viewing the investment world through the narrow lens of value investing has cost him dearly.

He missed out on investing in internet companies with wide moats like Google, Facebook and Amazon.

Here’s how Buffett explained his mistake.

First, internet business models never made any sense in the traditional value investor’s framework. Buffett failed to realize that, given how profitable they are, dominant tech companies could self-fund indefinitely. Traditional sectors like railroads and machinery never had that luxury.

Second, technology became more pervasive than Buffett ever expected. Software has penetrated the operations of every one of Berkshire’s “traditional” companies, from jet engines to banks. Software has become the essence of the business, and not just a sexy “bell and whistle.”

Of course, the real reason behind Buffett’s subtle mea culpa is that it is hard to argue with success.

The single most successful growth stock in the world over the past 20 years has been Amazon.com (AMZN). And founder Jeff Bezos — 33 years Buffett’s junior — just lapped Buffett in the world’s wealthiest sweepstakes with a net worth of $100 billion. No wonder Buffett called Jeff Bezos “the most remarkable business person of our age.”

Buffett’s investments have now started trending toward technology companies.

Although Buffett’s initial foray into the sector through International Business Machines Corporation (IBM) was a wash, his recent most position in Apple has soared.

Berkshire now owns 134 million shares of Apple stock, worth $23.5 billion. That makes Apple Berkshire Hathaway’s single most significant investment after Wells Fargo (WFC) and Kraft-Heinz (KHC).

Today’s investors would be surprised to learn that there is a long tradition of growth investors.

Silicon Valley’s Philip Fisher and the “Sage of Baltimore” T. Rowe Price were the Andreessen’s of their day.

They made a lot of money with philosophies other than value investing.

The lesson?

Understanding that many more companies are growing exponentially today than ever before does not mean you are buying into the next dotcom style bust.

Take the blinders off, and don’t overlook the highly profitable investments to which many value investors remain blind.

In case you missed it, I encourage you to read my e-letter from last week about this time-tested investment strategy.