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Is Technology Threatening to Attack Buffett's Empire?

Oct 15, 2015

In this issue:
» Wealth disparity reaches astonishing proportions
» India ranked most attractive investment destination in global survey
» ...and more!

00:00
We won't try to hide it.

We are worried...

The continuous assault of technology poses a risk to the competitive advantage - the moat - of many businesses.

The question we are asking is this: What are the chances a new technology destroys the moat of a company over the next 5-10 years?

This question even has Warren Buffett losing sleep. The businesses he once considered impregnable fortresses are now under attack from technology.

Take insurance giant GEICO for example.

The Oracle of Omaha loves this stock so much that when he counts his blessings, he counts GEICO twice! GEICO has been a goldmine for Buffett, but will the future of the company be as bright as its past? Buffett doesn't think so. He is worried that self-driving cars will destroy GEICO's business.

Let's be clear. Self-driving cars are years away from mass adoption. But the threat to GEICO's moat is real and should not be shoved under the carpet. Self-driving cars could dramatically reduce accidents...and insurance premiums.

Many businesses face similar threats from technology.

India's very own software sector is in danger of losing a large part of its business to robots. This is true especially for low-end work. This is why every IT firm worth its name is trying to move up the value chain and stay relevant.

Even pharmaceutical managements are on perpetual tenterhooks. In one fell swoop, a breakthrough can make their whole business model irrelevant.

In fact, we are tempted to claim that hardly any sector is free from the threat of technology. And if this is indeed true, the implications for the moat investor are serious.

Is Buffett's favourite wealth creation strategy losing its edge? Is moat investing dying?

We don't think so. Some of Buffett's businesses are indeed under attack from new and better technologies. But the majority of the kinds of businesses he has invested in will see record profits 5-10 years from now. And technology will actually accelerate - not deteriorate - their profits.

Consider Coke, an old Buffett favourite. Coke's been making a product that's fundamentally unchanged for more than 50 years. And there's no reason to think any technology will impact the way it is produced and consumed fifty years from now.

The million-dollar question, therefore, is how to separate the wheat from the chaff...how to identify businesses with widening, not narrowing, competitive advantages.

We believe it has to do with the point of attack. If a new technology thrusts a dagger in the heart of a competitive advantage, then alarm bells should be ringing.

Let's go back to GEICO to understand this better. GEICO's moat comes from collecting premiums from drivers. However, self-driving cars threaten the very concept of drivers. Therefore, Buffett is certainly right to worry about GEICO's moat.

Another example is erstwhile photography giant Kodak. The company's moat, its cash cow, was the camera film business. The rise of digital technology and mass adoption of camera phones thrust a dagger into Kodak's heart, leading the company to declare bankruptcy. Here again, technology hit where it hurt the company the most, its competitive advantage.

No doubt technology has made moat investing riskier, but wealth creation through competitive advantage isn't going away any time soon. To account for the rising threat of new technology, ask these two questions: First, what is the firm's competitive advantage? And second, can any new technologies strike at the heart of this competitive advantage?

What do you think? Do you think the pace of technological developments will kill the concept of moat based investing? Let us know your comments or share your views in the Equitymaster Club.

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02:18
 Chart of the day
We love to look back and marvel at the rapid strides India has made over the last decade or two. And even as this may be amply justified, a recent study conducted by Credit Suisse throws up some startling facts.The richest 1% of Indians own a mind-boggling 53% of the country's wealth! This, even as at the other end of the spectrum 50% of Indians make do with a paltry 4.1% of wealth.

Yes, we all have a general inkling of the wealth disparity prevalent in the country. But just 1% of Indian citizens owning more than half the country's wealth is plain obscene. And for all the development that the country has made since the year 2000, the most well-off section of society have managed to keep on increasing their share of this expanding pie. Sample this: They owned just 36.8% of the country's wealth in 2000. And as today's chart shows, they have seen a consistent rise through the years, almost like clockwork.

In fact, this is one game where we have even managed to beat the mighty US, where the richest 1% own 37.3% of the total country's wealth. Seeing the consistency and extent to which the rich have managed to become richer in India, it has to be structural factors - in the way we're set up as an economy - that are the cause of this. Over the long-term, nothing good can come out of such extreme imbalances. We as a society need to correct this before it is too late.

Wealth disparity of astonishing proportions

03:18
The going may not be very good for the distribution of wealth in India. But as far as attracting investment is concerned, the country may well be in a sweet spot right now. According to a report in the Mint, India has been ranked as the most attractive investment destination in the world for the next three years. Highlighting a survey conducted by accounting firm EY, the business daily goes on to cite 32% of global business leaders as having favoured the country as an investment destination over all others. China and Southeast Asia come in at a distant second and third with 15% and 12% of them favouring these countries. Interestingly, over 60% said that they had plans to invest in India over the next year to set up their manufacturing here.

However, before we get too excited about such positive sentiments towards India, we must remember that many obstacles remain. Infrastructure bottlenecks along with the painfully slow pace of reforms being two of the biggest. Further, sentiments can change, and often quite capriciously. They may have moved towards being more positive currently. But they can just as easily take a turn for the worse if the negatives plaguing our economy are not dealt with soon.

04:30
The Indian stock markets were trading strong today on the back of sustained buying activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 245 points. Gains were largely seen in auto and banking stocks.

04:55
 Today's investing mantra
"Value investing is risk aversion." - Seth Klarman

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This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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1 Responses to "Is Technology Threatening to Attack Buffett's Empire?"

Rajagopalan Ramesh

Oct 15, 2015

Technology's penetration in any business is really intimidating and has the potential to ruin the wealth creation. Even in the case of stock investing, newer technologies like Algorithmic Trading may kill the opportunities available for retail investors - as Big sized Insurance Companies / Banks / Mutual Funds / FIIs / DIIs etc., will have the ways and means to invest in the required tools and automate the stock trading - trying to cash on at every opportunity available in the market. Algorithmic validations if properly set up, will also throw up plenty of opportunities available based on fundamental analysis as well. By the time a retail investor starts taking any action, the price would have already reacted in the market. Now there are big brokerage houses in Mumbai trying to voice their concerns about Algorithmic Trading and demand ground rules to be set up by SEBI ? It is only our hope that any new technology may open up a different door to the persons engaged in a particular business and save them eventually.

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