What’s behind today’s fall?

The Telegraph reported on Tuesday evening that a current Darktrace executive has been named in a judgement concerning malpractice in the sale of Autonomy to Hewlett Packard in 2011. The judgement — handed down on Tuesday — found that Autonomy’s central management had pulled accounting “levers” to misrepresent how well the Cambridge-based business was doing ahead of its sale.

Justice Robert Hildyard highlighted Nicole Eagan, then Autonomy’s chief marketing officer, as “part of a clique responsible with the defendants of the operation of the impugned levels”. Eagan left Autonomy to set up Darktrace with a number of other tech experts. He served as chief executive until 2020, before moving to become Darktrace’s chief strategy and AI officer.

The judgement also accuses Mike Lynch, who founded Autonomy and served as an advisor to Darktrace until earlier this year. The judge accused Lynch of over-inflating the firm’s value, and he now faces a civil case. The British entrepreneur denies all claims made against him.

Autonomy was bought by HP for $11.7bn. However, one year later, the US tech giant wrote down the value of the business by $8.8bn. It claimed the selling price for the business had been massively over-inflated.

What does this mean for Darktrace?

In theory all this has little impact on Darktrace. However, investors will be concerned that a top executive may have been involved in malpractice that saw a company’s valuation distorted. This may compound worries that already existed about Darktrace’s share price. The stock has jumped up and down since its IPO with investors unsure of its real value.

Should I buy Darktrace?

Recent updates from and about Darktrace have been rather positive. For a start, in April, the AI firm increased its annual revenue guidance after adding 359 net new customers in the third quarter. Darktrace said it added $35.4m of annual recurring revenue (ARR) in Q3 and $105.3m in the nine months to the end of March. These figures include the acquisition of Cybersprint in March.

This was followed by a positive broker appraisal. Analysts at Jefferies issued the cyber-defence company with a ‘buy’ rating, noting the group’s “positive” third-quarter trading statement. Jefferies has a 730p target for the stock, more than double today’s price.

However, there are concerns about the path to sustainable profitable growth. Shortly before the Q3 update, JPMorgan Cazenove raised noted that high competition, relatively low platform lock-in and customer stickiness could hurt long-term profitability.

Despite this, and the other concerns, I see today’s fall as a good opportunity to buy. There’s a considerable focus on cyber-security following Russia’s invasion of Ukraine and the increasing tensions between Moscow and the West. I think the prospects are strong for Darktrace and I’m looking to add it to my portfolio.

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Apple

Buffett took decades to buy shares in Apple (NASDAQ: AAPL). But when he finally invested, he certainly made a profitable choice. At the end of last year, Buffett’s $31bn Apple shareholding was showing a $130bn profit even before taking dividends into account.

The company is now the largest shareholding in the portfolio at Buffett’s company Berkshire Hathaway. Although Buffett has sold some of his Apple stock – perhaps to avoid overconcentration in his portfolio as the price rose – he still owns most of the stake he built up.

Pundits seem constantly to be predicting imminent bad news for the Apple share price, due to a perceived lack of innovation. But I see that as positive. Apple’s disciplined approach of keeping its product portfolio small makes it simpler for the company to focus on a few blockbusters. It reduces cost and complexity in the business. The brand remains aspirational and has a large installed customer base. That helps generate massive cash flows. Operating cash flow last year was $2bn a week.

I have some valuation concerns about Apple given its price-to-earnings ratio of 26. That looks pricey to me. But the company does have a proven ability to produce strong earnings growth. For that reason, I would consider buying it for my portfolio.

American Express

Buffett’s position in financial services giant American Express (NYSE: AXP) has an interesting history. He bought it during what was known as the ‘salad oil scandal’. A small company was involved in a form of invoicing fraud. But the consequence was huge for a number of financial services shares.

The news hammered the American Express share price. But Buffett reckoned it was a storm in a tea cup. The business concerned was connected to only a very small part of American Express’ revenue. So when the stock market beat down the Amex share price, Buffett loaded up. He now owns 19.9% of the company. That stake cost him $1.3bn but has risen in value to $24.8bn.

It is a classic example of Buffett “being greedy when other investors are fearful”. The basic economics of American Express give it what the ‘Sage of Omaha’ calls a moat, or competitive advantage. The brand is prestigious and has a large installed base of both users and merchants. But Buffett was able to buy it at an attractive price. Can I?

Currently, Amex trades on a P/E ratio of around 18. I would prefer it to be cheaper, so if there is a pullback in the share price I would consider buying it for my portfolio. I see Amex as the sort of business that has excellent long-term prospects. But growing economic weakness in key markets like the US could see borrowers defaulting more. That may hurt profits. If that concern leads to a share price fall, it could give me a buying opportunity.

Coca-Cola

Another longstanding holding in Warren Buffett’s portfolio is the drinks maker Coca-Cola (NYSE: KO). As well as its namesake sugary drink, the company owns a wide portfolio of brands in markets worldwide.

Again, this is a business with a classic Buffett-style moat. Only Coca-Cola has the brand name and formula for its most famous drink. It also has a complex set of distribution arrangements that effectively mean it is the default soft drinks supplier to many retailers and other drinks outlets. The manufacturing cost is low, which means Coca-Cola can benefit from high profit margins.

Although there is a risk that health-conscious consumers will increasingly shun ‘unhealthy’ drinks, the company has been trying to diversify its portfolio for years to help it reflect this concern. Meanwhile, the underlying business model remains attractive. I think it could stay profitable for decades to come.

But while the Coca-Cola share price has increased 22% over the past year, I find it hard to get excited about the prospect of owning the shares. At 28, its P/E ratio is higher than Apple’s – but I do not think its earnings growth prospects are anywhere near as promising. At the moment I would not buy Coca-Cola for my portfolio.

HP

Warren Buffett’s latest shareholding, announced this month, is in computing equipment company HP (NYSE: HPQ).

I find it hard to see HP as a great company. It has some brand recognition, both in computers and printers. But if I think about the sort of comments I hear from Apple customers, the comparison becomes stark. I cannot remember anyone ever raving to me about an HP product let alone the HP brand.

Where is the moat here? The business model may be attractive – overpriced print cartridges are a classic example of the so-called razor and blade model where pricey refills offer attractive profit margins. But that is true of any printer maker, not just HP.

I just do not see what is compelling about the HP business and would not buy it for my portfolio.

Verizon

Another company that does not excite me much is telecoms provider Verizon. But while the brand may not elicit much emotional response from me, the business model is something I do find attractive. Due to the high capital expenditure required to build and run mobile networks, companies like Verizon that do it have a moat. Its huge installed customer base gives it economies of scale.

Demand for mobile telecoms is probably going to keep growing, in my opinion. It is a highly cash generative business. One risk is that that cash gets used up to fund the capex. But when that does not happen, a company like Verizon can generate big profits to fund dividends. With a 5.3% dividend yield, I would be happy to tuck Verizon away in my portfolio.

Investing like Warren Buffett

What works for Buffett will not necessarily work for me as an investor. But using a similar approach of looking for excellent companies at attractive prices, I could see myself buying several of these shares for my own portfolio.

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Low HP

Warren Buffett has always preached his main investing philosophy. He encourages only buying shares in companies that have solid balance sheets, quality earnings, and strong pricing power. This is why I was left surprised when I saw his holding company acquire $4bn worth of stock in HP.

HP’s balance sheet certainly isn’t in a healthy position. With a -304.4% debt-to-equity ratio, the tech company has negative shareholder equity. This means that the company’s liabilities exceed its assets. Its cash and equivalents are not sufficient to cover its debt either, with only $3.4bn in cash and $7.1bn of debt. As a result, I am left scratching my head, as HP’s balance sheet doesn’t add up to the fundamental investing strategy of Warren Buffett.

Printing money

Nonetheless, the silver lining in HP’s dire balance sheet is that it manages to generate quality earnings. Since Q1 2021, HP has managed to grow its revenue and profit margins. The firm went from a 5.6% profit margin to 10.1% in its most recent quarter. In addition to that, HP has shown its intention to continue growing its business. Just last month, HP announced its acquisition of Poly, a voice and video solution company. This should boost HP’s growth strategy, as it aims to build a leading portfolio of hybrid work solutions.

More importantly, HP trades at a low price-to-earnings ratio of six, while also paying a decent dividend of $0.25 per share. It is perhaps for those reasons that Warren Buffett opted to invest in one of the world’s biggest PC manufacturers, as he expects HP to continue generating compounding amounts of free cash flow.

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Unfortunately, that is all the good news I have for HP. Despite the positives of the company, there are worrying trends that the PC giant faces. For one, market analysts are forecasting that PC growth will slow down considerably as inflation continues to eat away on consumers’ income. It doesn’t help either when UBS gives HP a stock downgrade, citing weakening demand for HP products, with Wall Street also expecting the S&P 500 company to see a decline of 12.4% in its earnings. Moreover, HP isn’t the market leader as it trails its rival, Lenovo, giving it less pricing power.

As such, despite HP’s value proposition, I don’t think the stock will be performing considerably well for the foreseeable future. The company’s balance sheet also leaves much to be desired, which is why I will not be buying HP shares for my portfolio any time soon.

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Buffett invests in US tech company

Buffett’s company Berkshire Hathaway announced yesterday that it has built a stake of around 11% in HP (NYSE: HPQ) for roughly $4.2bn. HP, better known to many of us under its old name Hewlett-Packard, is the personal computer and printer business that was left over when the company’s B2B operation was spun off as Hewlett Packard Enterprise in 2015.

The company looks cheap at the moment, trading on a price-to-earnings ratio of just eight. It is dividend-paying, with a yield of 2.9%. Revenues and earnings both grew last year. Around two thirds of sales came from personal systems, such as laptops. That area saw 18% annual revenue growth. The rest of HP’s sales come from its printing division, which grew around 14% last year.

The attractions of HP

It has a fairly strong brand, something Warren Buffett sees as giving a company pricing power. Its business generates substantial free cash flow, which is also something Buffett likes a lot. Such free cash flows enable dividends.

I reckon in its printing division at least, HP benefits from the “razor-razorblade model” taught in business schools. Just as with a Gillette razor, when consumers buys an HP printer, they are likely to buy HP ink cartridges to refill it. So even if profit margins on the initial product sale are low, there is lots of money to be made on selling peripherals such as ink. As a buyer of such cartridges, this price gouging infuriates me – but it has a clear business logic.

The current valuation also makes HP look fairly cheap. Buffett likes to buy great companies at good prices. HP is trading less than 15% below its all-time high price, but from a valuation perspective I do not think it looks expensive.

Should I follow Warren Buffett?

Buffett has been wrong in this space before, however. He bought IBM when it too had an attractive business outlook and dividend yield. The company went into a prolonged period of falling revenues. Buffett eventually sold his whole stake, apparently at a loss.

He has been far more successful with Apple. But to me, HP looks more like IBM than Apple. Prospects for long-term demand growth look doubtful. I see printing as something that is likely to decline, not grow, and laptops might end up going the same way because many people now just use their phones. While Apple has brand fanatics, I do not think the HP brand is as powerful. It still gives the company some pricing power. But I do not think the HP brand gives the company the sort of pricing power Apple has.

Given its current valuation, the HP share price could well increase in the coming years. But from a long-term investing perspective, I do not see it as the sort of great business in which Warren Buffett usually likes to invest. I will not be following him and buying HP for my portfolio.

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WASHINGTON, DC — Last month, an incredible streak was broken in international sports. In a football match against Spanish League adversary Rayo Vallecano, Futbol Club Barcelona walked off the field with fewer minutes of ball possession than their opponent for the first time in 136 games. The game (which Barcelona won 4-0 nonetheless) marked the first time in three years in which Barcelona, or Barca, as it is popularly known, did not win the battle of possession.

One of the world’s elite football teams, Barcelona has enjoyed success that stretches across decades. While borrowing from different football philosophies, Barca’s style and system are unique in the football world. The principles by which the team plays, moreover, translate well into the world of investing. Let’s review four hallmarks of Barcelona’s style that have parallels in that most unheralded of sports: long-term equity investing.

One-touch, two-touch

The Barcelona style is affectionately referred to by fans as “Tiki-Taka” football. Tiki-Taka is a Spanish onomatopoeic term roughly similar to “click-clack,” the sound of the ball being passed crisply from one player to the next using only one or two touches.  This makes for remarkably efficient ball movement and furthers the primary obsession of possessing the ball. The Tiki-Taka concept maximizes ball sharing between players.

Outside game day, Barca players (whose average club salary would make any NBA owner reach for an Alka-Seltzer) relentlessly practice fundamental drills, some of which even preschoolers can emulate. In my personal favorite practice set, called “rondo,” players form a small circle, and play keep-away from two chasers in the middle, using one-touch passes. While the speed at which the team moves the ball can resemble a Japanese pachinko game, the underlying premise is utterly simple.

Investing Parallel: Buy companies that structure themselves to exchange ideas quickly and fluently.
Susan Wojcicki, employee number 16 at Google (NASDAQ: GOOG.US) and now a senior vice president of product management and engineering with the company, had this to say on idea sharing in an insightful article entitled “The Eight Pillars of Innovation:”

By sharing everything, you encourage the discussion, exchange and reinterpretation of ideas, which can lead to unexpected and innovative outcomes. We try to facilitate this by working in small, crowded teams in open-cube arrangements, rather than individual offices.

This past week, Google’s share price crossed $1,000 on stellar earnings.This is due in no small part to the profusion of ideas that are monetized year in, year out at Google. Like the Barcelona rondo drill, companies that crowd teams together and share ideas quickly have an edge.

Keep possession of the ball

By passing the ball among themselves and denying the opposition touches, Barcelona mathematically reduces their opponent’s chances to score. Hoarding the rock also wears down the rival side, until a designated assassin such as Lionel Messi or Neymar da Silva Santos Júnior (known simply as “Neymar”) slices through the defense for the kill.

While some criticize Tiki-Taka as boring, it requires an immense amount of physical skill and keen decision-making to keep the ball within your team’s possession, to say nothing of the reserves of patience the team draws upon until it is the right time to strike. 

Investing Parallel: Buy companies that don’t give up market share easily.
While Coca-Cola’s (NYSE: KO.US) revenue growth rate has slowed over the last few years, the company just recorded its 25th consecutive quarter of increased market share by value. And just as statistically, teams that control possession tend to win more games, companies that obsessively increase market share while retaining profitability tend to make great long-term investments.

The importance of the triangle

The triangle is the basic unit of the Barcelona offense. During a game, three players loosely form into a triangle, and transfer the ball via those quick, one-touch passes. Approaching teammates from any angle instantly form more triangular possibilities. This forces other teams to run more and chase the ball while Barcelona players employ their keep-away skills, expending relatively less energy. It’s a simple, logical, and efficient field formulation of which Euclid, the father of geometry, would no doubt approve.

Investing parallel: Avoid companies whose business segments are organized inefficiently, and seek out companies with superior segment organization.
Part of Hewlett-Packard’s (NYSE: HPQ.US) current malaise is its patchwork of seven gargantuan and disparate business segments, which range from “Printing” to “Storage and Networking” to “Enterprise Servers” to “HP Financial Services.” Another tech bellwether, Oracle (NYSE: ORCL.US) , describes itself as operating in just three businesses: hardware, software, and services.Which company do you think has an easier time focusing on its business?

For the last several years, in any given quarter, Oracle’s net profit margin has landed in a range of between 20% and 30%. HP’s net profit margin — when it’s been positive — has fluctuated between 2% and 8%. 

Keep the defensive line high

When Barcelona moves the ball deep into enemy territory, the entire defensive line moves up. This puts enormous pressure on their adversaries, as the field effectively becomes smaller. As triangles multiply and the short passes fly, defense and offense merge into a single organism, zinging the ball at numerous angles, but moving it methodically ever closer to the goal.

Investing parallel: invest in companies that understand how to keep pushing their defense (their existing legacy business / cash cow) while innovating in new areas.
My favorite example of this philosophy is Cisco Systems (NASDAQ: CSCO.US) . Cisco has placed bets on a number of alternate revenue streams, for example, security, which is a small fraction (3.7% to be exact) of total yearly revenue of $48.6 billion.

Yet while it expands these areas, the company never loses focus on its strength in networking. This has paid off recently, as a good chunk of computing that is migrating to the cloud runs through Cisco’s networking. To quote CEO John Chambers from Cisco’s last earnings call, networks are “squarely at the center of the cloud, mobility, BYOD (Bring Your Own Device), [and] security…” 

Parting ‘shot on goal’

There are many more investing insights you can glean from watching the sophisticated Barcelona side play. Are you a fan of football? Let me know in the comments section below what other investing parallels you notice when watching Barcelona. And fans of arch-rival Real Madrid, feel free to weigh in on your phenomenal team as well!

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