Many investors who focus on a low price-to-earnings (P/E) ratio and high dividend yield in their search for value will have a hard time swallowing the maxim legendary investor Warren Buffett lives by: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”.
Today, I’m considering whether FTSE 100 phones giant Vodafone Group (LSE: VOD) (NASDAQ: VOD.US) is a wonderful company, and whether its shares are trading at a fair price.
Back in the late 1990s, TMT (technology, media, and telecom) stocks were all the rage, inflating what came to be known as the dot-com bubble. Buffett wasn’t interested. In 1998, he said: “I don’t know what the world will look like in 10 years and don’t want to play in a game where the other guy has the advantage over me”.
There was widespread surprise when, within a few years, Buffett was one of three investors who pumped $500m into fibre-optic network operator Level 3 Communications. However, this was not one of the regular equity investments, with an ideal holding period of ‘forever’, for which Buffett is famed.
Occasionally, Buffett will enter distress situations where he sees prospects for a substantial short-term return — but he doesn’t do so by buying ordinary shares. We saw an example during the recent financial crisis when he injected $5bn into Goldman Sachs, negotiating a deal that gave him a huge 10% yield on preferred stock.
The Level 3 investment was an earlier example of a company paying a high price for Buffett’s support. The famous buy-and-hold investor’s alter ego as a special situations trader gave his Berkshire Hathaway investment company a massive profit on Level 3 in a short space of time. But Buffett reiterated to Berkshire’s shareholders that telecom companies weren’t his idea of wonderful long-term investments:
“I don’t have the faintest idea how to evaluate what telecom companies will look like down the road … I know people will be drinking Coke, using Gillette blades and eating Snickers bars in 10-20 years and have a rough idea of how much profit they’ll be making. But I don’t know anything about telecom. It doesn’t bother me. Somebody will make money on cocoa beans, but not me. I don’t worry about what I don’t know — I worry about being sure about what I do know”.
That seems to thoroughly knock on the head the idea that Vodafone could be considered to be a wonderful company in Buffett terms.
However, Buffett has more recently done a U-turn on investing in technology. During 2011, he took a $12bn stake in 100-year old tech titan International Business Machines (IBM). Buffett told CNBC he had been “hit between the eyes” by the company’s competitive advantages, including the significant difficulty of customers moving away from IBM.
Unfortunately, strong competition in the telecoms sector, customer churn and profit margins all suggest Vodafone doesn’t have the competitive advantages enjoyed by IBM.
Still, just because Vodafone isn’t a Buffett-style wonderful company, doesn’t mean investors haven’t made money from it. As Buffett said, somebody will make money on cocoa beans — it just won’t be him.