Why Buffett Passed On Microsoft

During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Why Buffett Passed On Microsoft Corporation (NASDAQ:MSFT). Here’s an excerpt from the episode:

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Buffett On Microsoft

Bill: John Huber posted on December 19th of 2019. He recently tweeted about it, about Warren Buffett’s 1997 email exchange on Microsoft. Notice how I’m on my phone now and not like this, folks. I’ve learned and the iPad is down.

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[laughter]

Tobias: Yeah, that was funny.

Bill: That was actually funny.

Jake: How are you going to eat that meatball sub though? [chuckles]

Bill: I don’t know. I won’t be able to hide it, although the shirt will if I dropped anything on it. Anyway, like Buffett said– basically he goes through like why he’s so certain about Coke winning, going forward. And he says your analysis of Microsoft, why I should invest in it and why I don’t could not be more on the money. In effect, the company has a royalty on a communication stream that can do nothing but grow, dot-dot-dot, whatever. He said– but forced to make– sorry, something about like, if I were to calculate the probability with a degree of certainty of 80% or 55% for a 20-year run would be folly. If I had to make such decisions, I would do my best. But I’d prefer to structure investing as a n called strikes game.

To me, where I do think that there is a legit knock on Buffett’s strategy for a certain personality, not for Buffett, because he has his lens that he sees the world through. But if you have a 55% shot at being right on Microsoft, and you think that it’s that nascent in the game, in my opinion, you swing. You maybe don’t need to take a 10% position. But if you really think the right tail is that long, the right tail makes that probability set reasonably– like a decent bet. I guess that where I think you can get yourself into a lot of trouble is you can convince yourself that everything is a right tail event. I do think you’ve got to be really, really specific about what you’re looking for in the right tail. But what I think– I mean he has admitted. He was early advised into Microsoft. He saw Google early, and I think he needs to be more certain than at least my personality wants to invest in the way that I think that I can invest. Now, he’s the greatest of all time and I’m some schmuck, so take it with a huge grain of salt.

Jake: The Microsoft one is a perfect example of what makes this game hard, especially if you were managing other people’s money at that point and you bought Microsoft maybe a couple years later, let’s say–

Tobias: What vintage was it? Can you just remind us of the date?

Jake: He said 1996.

Bill: Well, that was ’97 when that was first described him.

Jake: So, two years later, let’s just use that as a jumping-off point, and you were to buy Microsoft then, you didn’t go anywhere for what 12, 14 years, I think.

Tobias: That’s right.

Bill: The business went a long way.

Jake: The business went a long way but the other people’s money you’re managing, they don’t give a shit about the business changing. Their account value hasn’t changed in a decade. What are you doing here? I’m trying to point out how much patience is required, and you have to be right about the business analysis too that Microsoft is going to be so good for so long. That’s a really hard game to play.

Bill: Yeah, well, this is my buddy, The Science of Hitting Investing, and I joke about this a lot. People will shit-post on banks, and he’ll like send, “Well, this is book value per share,” but nobody wants to hear it right because the multiple fade has destroyed the growth in book value per share. But it’s if you actually look at the business, no, it’s not some software compounder, no one agrees that. We all get it, but they’re not nearly as bad as the stock price drives narrative story.

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The Acquirer’s Multiple® is the valuation ratio used to find attractive takeover candidates. It examines several financial statement items that other multiples like the price-to-earnings ratio do not, including debt, preferred stock, and minority interests; and interest, tax, depreciation, amortization. The Acquirer’s Multiple® is calculated as follows: Enterprise Value / Operating Earnings* It is based on the investment strategy described in the book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, written by Tobias Carlisle, founder of acquirersmultiple.com. The Acquirer’s Multiple® differs from The Magic Formula® Earnings Yield because The Acquirer’s Multiple® uses operating earnings in place of EBIT. Operating earnings is constructed from the top of the income statement down, where EBIT is constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–earnings that a company does not expect to recur in future years–ensures that these earnings are related only to operations. Similarly, The Acquirer’s Multiple® differs from the ordinary enterprise multiple because it uses operating earnings in place of EBITDA, which is also constructed from the bottom up. Tobias Carlisle is also the Chief Investment Officer of Carbon Beach Asset Management LLC. He's best known as the author of the well regarded Deep Value website Greenbackd, the book Deep Value: Why Activists Investors and Other Contrarians Battle for Control of Losing Corporations (2014, Wiley Finance), and Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors (2012, Wiley Finance). He has extensive experience in investment management, business valuation, public company corporate governance, and corporate law. Articles written for Seeking Alpha are provided by the team of analysts at acquirersmultiple.com, home of The Acquirer's Multiple Deep Value Stock Screener. All metrics use trailing twelve month or most recent quarter data. * The screener uses the CRSP/Compustat merged database “OIADP” line item defined as “Operating Income After Depreciation.”