Why Buffett Would Not Buy Google

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Includes: BRK.A, GOOG
by: Wayne Mulligan

This weekend on TickerHound.com, a member asked, “Would Buffett really buy Google (NASDAQ:GOOG)?”

The question was based on a Fool.com article that quoted this year’s Berkshire (NYSE:BRK.A) Annual Shareholder Letter where Buffett writes, “It’s far better to have an ever-increasing stream of earnings with virtually no major capital requirements. Ask Microsoft or Google.”

I could see why this led some to wonder – and the Fool.com even wrote an article about it – if Buffett could potentially invest in Google. This made me laugh if for no other reason than Buffett mentions Microsoft (NASDAQ:MSFT) in the same sentence, a company he knows intimately (considering Bill Gates sits on Berkshire’s board) but has yet to ever invest in.

But let’s leave that part out of the equation for a moment. Let’s just look at the Google angle and try to answer the question: Would Buffett really buy Google?

For consistency’s sake, I’m going to analyze this in the exact same way the Fool.com article did:

Is The Business Simple and Understandable?

Definitely!

Google is an ad broker – plain and simple.

We can talk about its technology all we want – and believe me, that’s what makes its ability to broker ad dollars so effective – but at the end of the day, the way the company makes 99% of its money is by putting publishers and advertisers together.

That’s a pretty plain vanilla business to me (regardless of all the sophisticated search technology it has on the backend).

Does It Have Favorable Long Term Economics?

I’m going to skip this for a moment and come back to it at the end. You’ll see why below.

Is Management Candid and Competent?

I’d have to give the affirmative answer on this one as well.

The founders, Larry Page and Sergey Brin, both have the better part of their net worths tied up in Google stock. That means management’s interests and the shareholders’ interests are certainly aligned – something Buffett always looks for in a company he’s buying.

And in terms of candor and competence, their execution speaks for itself. If you’ve read Google’s annual reports and even its S-1 filing, you’d know that they’re candid and up-front about how they manage their business.

So this item gets checked off the list as well.

Is The Price Right?

Here’s where we run into problems…

Buffett’s brilliance isn’t based on the fact that he knows how to value an asset…I know a lot of folks who can value an asset.

My father knew exactly what we should pay for our home when I was a kid.

I could tell you right off the bat how much I’d pay for a new car.

In fact, Finance 101 teaches people basic asset valuation models – more specifically, Discounted Cash Flow analysis.

The ability to value an asset isn’t difficult, you just plug some numbers into the equation and you get your value.

The difficult part is making sure the NUMBERS themselves are the right numbers.

So now you’re probably asking, “How do we know if the numbers we’re using are correct?”

Well, you’ll never be able to tell if the numbers are EXACTLY correct, you’ll have to use your best judgment. And even then you’re probably going to be off, and that’s why in Ben Graham’s infinite wisdom he taught Buffett – and thousands of other value investors – to apply a “margin of safety” approach to business valuation, but that’s another story.

But here’s the caveat (and this goes back to the “Does the business have favorable long term economics?” question). According to the Fool.com article, because the internet has favorable long term economic characteristics, and Google is by far and away the leader of the internet pack at the moment, they assume that Google will therefore have favorable long term economic characteristics as well.

But that just isn’t so. The tech sector is predicated upon the process of creative destruction. Companies must find new and innovative ways of doing things or they’re destined to become obsolete. I mean, how many times have we seen this happen in the last 10 years?

To argue that Google will ALWAYS maintain a competitive advantage in a space that changes by the hour is foolish (no pun intended).

That’s why Buffett only invests in mature companies that compete in mature industries. It makes the tough part of business valuation (using the right numbers) much, much easier.

So to answer the original question as simply as possible, Would Buffett ever buy Google?

In my opinion…Not anytime soon!