InvestorGuide.com
The only investing site you need.
InvestorWords.com
The biggest, best investing glossary on the web.
Syndicate / Link to Tomments.com
If you operate a web site and/or a newsletter and would like to make Tomments available to your audience, click here for all the details on our free syndication program.
Tomments 10
Internet Value Investing [1 page, 07/26/01]
Tomments 9
Analyzing the Analysts [1 page, 6/21/01]
Tomments 8
Darwin, Inc. [1 page, 03/21/01]
Tomments 7
The Big Picture [1 page, 12/05/00]
Tomments 6
Politics and Investing: What qualities do you look for in a presidential candidate? A CEO? [2 pages, 11/06/00]
Tomments 5
The New Relationship Between Price and Value [1 page, 09/26/2000]
Tomments 3
What is the difference between gambling and investing? [2 pages, 07/06/00]
Tomments 2
Who are the best stock pickers? [3 pages, 04/19/00]
Tomments 1
$7.5 million for the business.com domain name: too much? [1 page, 12/07/99]
Is Bill Gates a good investor? Can you profit from his investments?[1 page, 08/23/00] Introduction | Cascade Investment LLC
Microsoft's Investments and Acquisitions | Conclusions
Related Links | Feedback
Email this article to a friend
|
Introduction Like him or hate him, you probably agree that Bill Gates is an exceptional businessman, having built one of the world's most valuable companies from the ground up. In the process, he became the wealthiest person on the planet. He obviously knows what it takes to be a successful businessman. But does he also know what it takes to be a successful investor? More specifically, can individual investors learn anything from him that would help them improve their own investment results? Many investors seem to think so: when it is revealed that Bill Gates or Microsoft has made an investment in a company, that company's stock usually jumps, often dramatically. At first glance this seems reasonable, as superior businessmen are often superior investors. But a closer look might lead to a different conclusion. So let's examine Bill Gates' investments, both through Microsoft and through his own portfolio, to see what they imply about what he thinks is investment-worthy, to see how good his track record is, and to determine whether they reveal any clues individual investors can use to help their own performance. Cascade Investment LLC The vast majority of Bill Gates' wealth is tied up in Microsoft stock, which he sells a small percentage of each quarter. Most of this money is either donated to one of Gates' two foundations (The William H. Gates Foundation and the Gates Learning Foundation) or invested through Cascade Investment LLC. (Gates endows his foundations by giving them shares of Microsoft stock, which are then gradually sold.) Most of the money in the two foundations' coffers, 80% or more, is in short-maturity U.S. government and corporate bonds, although a variety of other instruments are held in small amounts, including inflation-protected Treasury bonds (known as TIPs), junk bonds, foreign government and corporate bonds, mortgage-backed securities, and a few stocks. But the foundations obviously have different objectives than an individual investor would, so their holdings aren't terribly instructive. Instead, let's focus on Cascade, Gates' personal portfolio. About 70% of Cascade is invested in short-term government and corporate bonds. Another 10% or so is in stocks. The remainder is divided into small amounts of emerging-market debt, junk bonds, private equity, short positions, commodities, and real estate. For the purposes of the current discussion, we're going to focus on the stocks, because the bond investments are not terribly instructive and the other investments aren't disclosed in sufficient detail to subject them to sufficient scrutiny. Moreover, individual investors probably wouldn't be able to make those other investments anyway, since some are restricted to very wealthy investors and others are intended primarily for experts in exotic instruments. So what's in the portfolio? Here are some of Cascade's major recent investments:
Does anything about this list surprise you? Perhaps the dearth of high-tech stocks? After all, only four of the fourteen would be considered tech stocks, and three of those are in biotech, rather than computing, Gates' specialty. Could it be that Gates' friend and fellow billionaire Warren Buffett has persuaded him that technology, especially the internet sector, is tremendously overvalued? For example, Buffett's Berkshire Hathaway bought 130 million ounces of silver in 1998, and shortly thereafter Cascade placed a large bet on Pan American Silver. Gates has said repeatedly that he thinks the internet sector is frothy, but I've ignored those statements because he has a vested interest in discouraging billions of dollars of venture capital and retail capital from being put in internet startups' coffers. But with these low-tech investments, he's literally putting his money where his mouth is. However, it's entirely possible that Gates is bullish on the tech sector, and is avoiding it for another reason: diversification. After all, about 90% of his portfolio is still Microsoft shares. Nevertheless, Gates doesn't seem like the risk-averse type, having placed large bets on behalf of Microsoft many times over the last two decades. Perhaps he's only risk-averse when he isn't in control of the outcome. On the other hand, if Gates could consistently pick winners in the tech sector, I think he would probably be doing it, and since he isn't it's safe to assume that he doesn't have a tech stock crystal ball. Does Bill Gates know how to invest? People seem to think so. An announcement of a Cascade investment generally sends a stock up 10-20%, and the ones that appear to be tech plays often see the biggest jumps. When Cascade announced its investment in Avista on January 21, 2000, investors jumped on board and sent the stock soaring over 40%, presumably on the belief that Gates thought Avista's expansion into telecom and e-commerce would be hugely successful. But the fact that stocks jump when Cascade announces an investment in them means many people don't understand the situation. Here's why: Cascade's funds have been managed by a man named Michael Larson, not by Gates, since 1994. Gates says Larson has full discretion over the portfolio, and Larson makes the stock picks, with the exception of some of the biotech names, which Gates chooses himself. Investors who buy a stock based on the news of a Gates investment probably don't realize that it's not him that's making the decision. But just because Gates isn't making these decisions doesn't mean they should necessarily be ignored. As the world's wealthiest person, Gates should be able to afford the world's best stock picker. So is Michael Larson, the man behind the picks, worth following? His background is respectable: an MBA from the University of Chicago, several years at Arco doing M&A, and several years at Putnam Investments managing bond funds. He doesn't have a reputation as a world-class stock picker, just a down-to-earth investment manager. His focus is on asset allocation and risk management, not capital appreciation…in other words, he's doing the job he's paid to do. But that probably means that you don't want to read too much into his picks. But rather than assuming he's not a good stock picker just because he's not known for it, it would be fairer to examine his performance. Unfortunately this task is made difficult by several factors. First, due to fairly relaxed reporting requirements, Cascade doesn't have to reveal the exact price at which shares are purchased, nor in some cases the number of shares purchased, and there is a time lag between when purchases and sales are made and when they are made public. Second, as I mentioned, the portfolio also consists of real estate, commodities, short selling and other instruments and strategies that make an accurate calculation nearly impossible. With these limitations in mind, I calculated the approximate return of the publicly traded stocks in the above list and found their average return year to date to be 0.7%, vs. 2.0% for the S&P 500. But as any long-term investor knows, this is far too short of a period to judge performance, so I wouldn't want to read too much into these numbers. On the other hand, if you're not impressed by the performance, it might not be an indictment of Larson's skills. He has special considerations based on Gates' unique circumstances. Some of his stock investments are designed as a partial hedge against Microsoft's moves. In fact, that's another reason there's so much low-tech in the portfolio. He will presumably pick the best stocks he can find in those sectors, but these might not be the best stocks there are. You might be able to do better, since you don't have the same concerns he does (unless you also have nearly all of your wealth in a single tech stock). To summarize, it would be wise to treat Cascade's holdings as a low-tech value screen -- a starting point for your own research. But don't buy just because you think Gates has the Midas touch, because in most cases it's not even him doing the touching. The one exception to this rule is biotech, where Gates does make his own investment decisions (for example, Ceptyr, ICOS, and Pain Therapeutics). This is probably the only place we can learn what Gates thinks is investment-worthy. But is it within his circle of competence? Probably not. His expertise is in software. Additionally, the amounts he's investing in these companies represent such a small percentage of his wealth that they probably indicate an interest in the sector rather than a fundamental belief that the sector is sure to outperform. Microsoft's Investments and Acquisitions Acquisitions It's also instructive to consider Gates' other investments, the ones he's done through Microsoft -- both investments and outright acquisitions. Microsoft has made seven acquisitions in the last year: Bungie Software Products (video games), DriveOff.com (automotive e-commerce), Entropic (speech recognition), NetGames (video games), Peach Networks (digital TV), Softway Systems (operating systems), STNC (operating systems), and Visio (business software). Most of these companies are pretty small (with the notable exception of Visio), but Microsoft has made some larger acquisitions in previous years, including Hotmail (free email), LinkExchange (web site ad network), and FrontPage (formerly Vermeer, web site software). Microsoft's basic acquisition strategy is similar to other technology companies. They buy smart people, products, ideas, technologies and market leadership, especially in markets that have synergy with their current offerings, when doing so is faster and/or cheaper than developing the same stuff in-house. But their strategy does differ from that of many other tech companies in some important ways. They don't acquire companies just for the sake of sheer bigness. They don't jump on the latest tech fad just because the media has proclaimed it the next big thing. They rarely make high-profile purchases, because they understand that the larger the acquired company, the more likely it is for the acquisition to be a mistake. Also, they don't overspend. With more than $20 billion in cash and short-term investments, Microsoft could buy just about any internet company (except, of course, those that the Department of Justice wouldn't approve of). They usually purchase companies before they go public, when they're cheaper. For example, FrontPage, Hotmail and LinkExchange were each snapped up for around $150-350 million, far less than what they would be worth now as public companies. And they often pay with cash rather than stock. Many recent acquisitions in the tech sector were fueled by the acquirer's inflated stock price, and wouldn't have happened otherwise... Microsoft simply doesn't make such deals. Unfortunately, it's hard to quantify how good their acquisitions are, because once the acquired company has been swallowed up there's no way to determine the precise financial impact. But most of their deals do seem to pay off: Hotmail now has over 70 million users, LinkExchange is giving them direct access to over a million small internet businesses, and FrontPage and Visio are strong additions to their software applications suite. Since these are outright acquisitions, you can't mirror the moves the way you could if they were merely investments. But you could buy similar companies, reasoning that Microsoft tends to skate not where the puck is but where it's going. This strategy could prove to be dangerous, though, because whatever similar company you invest in is then a Microsoft competitor, which historically has not been an enviable position. Another approach would be to buy companies you think Microsoft is going to acquire. But if you want to play the M&A game, you'd probably do better predicting acquisitions in other areas, such as networking, since there are many more of them and the acquirers tend to pay larger premiums. While there's not much an individual investor can learn from Microsoft's acquisitions, one lesson worth taking away is that you should buy quality, but don't overspend for it... there's no company that's a bargain regardless of price. Investments
Investors seem to believe Bill Gates knows how to spot a good investment. Just as a Cascade investment gives a stock an immediate boost, a Microsoft investment often does likewise. For example, VerticalNet rose 20% when the Microsoft investment was announced. But a price jump following a Microsoft investment might be more logical than one following a Cascade investment, because in the former case the strategic alliance that accompanies the investment often has more of an impact than the money. In the case of VerticalNet, Microsoft agreed to market and support VerticalNet's B2B communities through its MSN network and bCentral small business portal, giving the startup a major advantage over its competitors. Unfortunately, it's difficult to quantify how good these investments are, for several reasons:
For similar reasons, even if their investments prove to be wise, it's not terribly easy for individual investors to benefit from watching them. Since Microsoft is making most of the moves for strategic reasons rather than capital appreciation, their goals are sufficiently different from an individual investor's goals to make attempting to mirror their moves a dangerous tactic. Furthermore, as was the case with Cascade, Bill Gates probably isn't too involved in the decisions. After all, he's only one guy, and he's not even the CEO anymore, having passed the baton to Steve Ballmer. Obviously Gates still has a lot of say in the big decisions, but most of the work involved in deciding what companies to acquire or invest in are made by other Microsoft employees. One might argue that he has put in place a system in which his underlings can make decisions the way he would, but this is easier said than done. (If Warren Buffett handed over the Berkshire Hathaway reins to someone else and described his system in detail to that person, how many Berkshire investors would expect the new guy to be able to match Buffett's performance over the long term?) Conclusions So now it's time to answer our original questions. Is Bill Gates a good investor? Based on the above analysis, examining Cascade and Microsoft unfortunately don't lead to a conclusive answer. Can an individual investor profit from Gates' investments? Again, the analysis argues that the best approach is not to try to mimic either Cascade's or Microsoft's moves, although we did find a few general principles that might be helpful, and we decided that watching their investments and using them as a springboard for further research is a valid approach. But perhaps we've been looking in the wrong place for the real lesson. What Gates does with his billions is certainly relevant to other billionaires, but the more valuable information to those of us who aren't yet billionaires but would like to be is how he got there in the first place. In the past, the easiest way to benefit from Gates would've been to simply invest in Microsoft. By doing so, your wealth would've grown in proportion to his. With Microsoft as big as it is, and with a breakup looming as a distinct possibility, it's unreasonable to expect the stock's future performance to match its historical performance. (In the interest of full disclosure, I should point out that I'm a Microsoft shareholder and intend to be one for a very long time. I'm confident that readers won't misperceive a conflict of interest here, because I'm not actually recommending the stock, and even if I were, the company is sufficiently large that my endorsement wouldn't move the stock price at all.) The lesson here is that the best way to amass wealth is to create and grow something of value by a reasonable percentage each year, year in and year out, ideally without cashing out or incurring tax consequences. The most popular way of doing this, and the way that Gates amassed his billions, is to own a share in a successful business that continues to grow year after year. As every long-term investor knows, compounding is God's gift to those with patience. And the IRS rewards it as well. Being a long-term investor in a company can enable you to defer capital gains taxes, allowing the compounding to proceed even faster, a benefit also enjoyed by those with IRAs or 401(k)s. This is also an integral part of Warren Buffett's success. He finds companies with a lasting ability to create value and holds them as long as the long-term picture remains intact, deferring taxes in some cases for as much as ten years. Whereas the stock market tends to rise about 10-12% per year over the long haul, small companies can grow much faster. While 20% a year is too much to expect from investing in most publicly traded companies, that's not the case for startups. If you start your own company or join a small startup, you may find that 20% a year is unnecessarily conservative, especially if you are investing your time and energy into it rather than just your money. Of course, to reach Gates' level, you'll need to shoot for 60% a year for a quarter of a century, but even if you fall a little short you'll still do fine. Taking this view, Gates is a good investor in that he repeatedly pumped nearly all of his wealth into his own company, where he felt it would get him the best return (and where he had a hand in shaping the performance). As it turned out, he was right. Joe Mansueto, Chairman of Morningstar, feels the same way. He said this a few years ago: "The best investment I ever made is a stock that I've held 16 years: Morningstar. I've never sold a single share of my original Morningstar shares, and any sale during the last 16 years would have been a bad one. Even if I could have received 25% more than fair value anytime during that period, it still would have been a mistake. Good companies can grow for a long time, and it takes patience to harvest their true value." It's important to note that you don't need to be the founder of the company to enjoy this long-term compounding effect. Microsoft co-founder Paul Allen is a billionaire, but Steve Ballmer is a billionaire too, and many of Microsoft's first hundred employees are decimillionaires. The key seems to be: find a winner as early as possible, stick with it for the long haul, and rack up equity slowly but surely, ideally by being an early employee of the company, but if not then by adding it to your portfolio before its growth spurt. When asked who the best investor of all time is, most say Warren Buffett, with the assumption that Bill Gates isn't eligible for consideration because he's not an investor. But maybe he is. What is the fundamental difference between business and investing? Both use capital and labor to create and extract value. The main difference is that for a businessperson it's partially his/her labor, while for an investor it's not. Indeed, Warren Buffett has said, "I am a better investor because I'm a businessman, a better businessman because I'm an investor." I consider myself both a businessman and an investor, often simultaneously. The line is further blurred by incubators, venture capital firms and others who are usually considered investors but are definitely hands-on. The same applies to companies, like Microsoft, which invest in other companies as part of their overall strategy. Additionally, while we looked at Microsoft's external investments in the above section, the other part of the story is the company's internal investments, the billions they spend on R&D each year to increase the value of their existing products and to develop new products. In this light, the differences between investing and business are not so pronounced and might be better examined in tandem. I should point out that I'm not arguing that making more money than you know what to do with should be your life's goal. (One could even argue that any system which allows for such large wealth inequities is far from optimal, but that's beyond the scope of this essay.) More to the point, you can apply this strategy to non-material pursuits as well. For example, if your passion is charity, try to help 20% more people this year than you did last year. Repeat the process in each successive year. In a few decades, you'll change the world. Some of you may be thinking: I wish I had read this when I was 25... but I'm not, so it won't work for me. I agree that since the strategy is a long-term one, those who are already retired or nearing retirement can't benefit from it as much as those just graduating from college. On the other hand, Colonel Sanders started Kentucky Fried Chicken with the $105 he got from his first Social Security check, when he was 65. It's never too late to get started. back to top page 1 of 1 Send feedback
|
copyright 2002 Thomas Murcko. All Rights Reserved.