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Should Berkshire Hathaway Analyze the Moats of Technology Companies?

Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) were asked a question relating to their long-publicized strategy of targeting businesses with wide moats - competitive advantages that set a company apart from their rivals and make it difficult to replicate their success. In the past, this has meant buying newspapers who had a monopoly in a particular area, or consumer staples with a very strong brand. At the 2019 Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) annual meeting, the pair was asked whether it is time for them to start looking for moats in the technology sector. Here is what they said.

The "why" and the "what"

Buffett began by acknowledging that moats can be very valuable in the tech sector, but said he believes that him and Munger are not particularly well-placed to identify these advantages:

"It is true that in the tech world, if you can build a moat it can be incredibly valuable. I've not felt the confidence that I was the best one to judge that in many cases. It wasn't hard to figure out who was winning at any given time or what their business was about, but there were a huge number of people who knew more about the game than I did. And we don't want to try to win at a game that we don't understand."

In other words, while Buffett and Munger don't find it very difficult to see which companies are doing well, the reasons why they are succeeding are harder to define. This is a valuable lesson for all investors: just because you can see that a business is making money doesn't mean that you should immediately jump in and invest - you need to understand the "why" as well as the "what."

If you do not understand the underlying economic fundamentals of the business you are analyzing, then you have no way of objectively deciding whether it is overvalued, undervalued or fairly valued. You may see that it is making more money every year, but if you do not know what it sells, who it sells to and what its competitors are doing, then you are not really in a good position to form an opinion on the business. Buffett and Munger feel that they are not in a good position to form an opinion on the tech sector.

With that being said, Buffett is not so concerned by the idea of missing out on the next Amazon (NASDAQ:AMZN) or Google (NASDAQ:GOOG)(NASDAQ:GOOGL):

"We'll do our best to enlarge the circle of competence of people at Berkshire so that we don't miss so many, but we'll miss a lot in future - we've missed a lot in the past. The main thing is to find things where our batting average is going to be high. And if we miss the biggest ones that really doesn't bother us so long as the things that we do do with money work out OK."

This attitude makes sense, and I think it is quite intuitive - most people would rather take a 90% chance of doubling their money than a 10% chance of quadrupling it. The idea is to be patient and invest in the things that you understand, and not worry so much if you miss out on the next huge thing.

Disclosure: The author owns no stocks mentioned.

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This article first appeared on GuruFocus.