One of the most quoted professionals in the investing world and one of the world’s most famous value investors, Warren Buffett, has stated many times that he dislikes technology stocks. Buffett claims that he dislikes these stocks as he does not understand them, which to some extent is true. However, perhaps more to the point would be the claim that technology stocks have no place in the world of value investing, as investing in technology is, even for the best in the business, speculation.

technology stocks

Now, obviously one exception here is International Business Machines Corp. (NYSE:IBM). Buffett counts the global technology behemoth as one of his four core holdings, although it is debatable if International Business Machines Corp. (NYSE:IBM) can be lumped in with the deluge of other technology stocks on the market. IBM is entrenched in the global technology market with more than a century of history and innovation behind it as well as a devoted management team; the main qualities Buffett looks for in any investment.

Aside from International Business Machines Corp. (NYSE:IBM), there are many aspects of tech investing that can be likened to speculation. During the past five years, according to data supplied by the FT, the average return of 340 equity funds with a focus on technology was an extremely unattractive 17.7%. And there are no better returns to be found elsewhere. Indeed, around 40% of venture capital backed tech companies fail, 40% only produce a moderate return and three out of four technology startups fail. So, it would appear that even the experts cannot pick the right tech companies for the long-haul.

Technology innovation keeps speeding up

For the most part, these failures are down to the rapid pace of technological innovation. New technologies are now being adopted much faster than they were, say, 100 years ago when devices like the automobile and telephone took well over 50 years to reach 50% adoption.

This process has now been greatly expedited. Certain apps for example, such as WhatsApp now dominate the global instant messaging market after only a few years of existence, pushing competitors out, before they have a chance to retaliate. The innovation adoption lifecycle also has a strong part to play in this. The innovation adoption lifecycle is the idea that the adoption of new technologist follows a bell curve comprised of innovators (2.5%), early adopters (13.5%), early majority (34%), late majority (34%) and laggards (16%); essentially fragmenting the market.

This faster adoption rate, and movement through the innovation adaption lifestyle has ultimately resulted in the shortening of company lifespans. In particular, back in 1958, the average time a company was expected to stay in the S&P 500 was 61 years, now, thanks to the rapidly changing technology market, the average has declined to just 18 years, an average which must leave long-term investors gasping for breath.

Trend is easy to see

Over the past few quarters this trend has been blatantly obvious, with Facebook Inc (NASDAQ:FB) and Alliance Data Systems joining the S&P 500, replacing the old guard of Hewlett-Packard Company (NYSE:HPQ) and Teradyne, Inc. (NYSE:TER) This churn goes back for years, with perhaps the biggest upset being the removal and following bankruptcy of Eastman Kodak Company (OTCMKTS:EKDKQ) during 2010. During 2010, Kodak, The New York Times Company (NYSE:NYT) and Office Depot Inc (NYSE:ODP) were replaced by F5 Networks, Inc. (NASDAQ:FFIV) and Netflix, Inc. (NASDAQ:NFLX), two rapid growth companies replacing Kodak, a company with plenty of history behind it and a company that could be considered, by some, to be a worthwhile value play.

So overall this constant churn of new tech companies with new ideas replacing the old before they get a chance to compete kills the idea of value investment in the tech sector. The sector is ultimately moving too fast for companies that are failing to be able to instigate a turnaround from a value valuation. In the tech sector the most popular companies attract the best talent and capital to be able to expand. Meanwhile, struggling companies that may look attractive on a value basis will have to spend heavily to innovate and these innovation will only have a 25% chance of success. With such a high rate of failure, the tech sector should be off limits for value investors seeking a margin of safety.

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