During the first half of 2008, Berkshire Hathaway Chairman Warren Buffett was ranked by Forbes as the richest man in the world, with an estimated net worth of $62 billion. He's amassed that fortune entirely through investing.
Following the credit crisis and the stock market dive, he's worth a bit less by now, but what's a few billion when you've got that much money? Regardless of his exact current wealth, Buffett's almost universally accepted as one of the world's greatest stock market investors. When he talks, it pays to listen.
Though Buffett is commonly considered a value investor, he seems just as focused on growth. Either way, he's proven that he's an intelligent investor. As Buffett's sidekick Charlie Munger once said, "All intelligent investing is value investing."
Google as a value stock
Buffett focuses on companies with favorable long-term economics and strong competitive advantages -- companies such as Burlington Northern (NYSE: BNI ) , ConocoPhillips (NYSE: COP ) , Coca-Cola, and M&T Bank (NYSE: MTB ) -- all current Berkshire holdings.
One Wall Street analyst called Coca-Cola "very expensive" around the time Buffett started buying it. It wasn't a typical value stock. But as Buffett once said about Coca-Cola: "If you gave me $100 billion and said, take away the soft drink leadership of Coca-Cola in the world, I'd give it back to you and say it can't be done."
Now that's a competitive advantage.
See, value investing is not all about buying stocks with low price-to-earnings, price-to-book, or price-to-sales ratios. Far from it.
For example, Google would have been a great value stock at its IPO in August 2004, despite selling at the time for more than 100 times earnings.
A value stock trading for more than 100 times earnings? Yep. Google was growing fast, continuing to take market share, and building sustainable competitive advantages in its enterprising culture, superior advertising platform, and brand loyalty. Given its growth rate since, and its powerful business model, it was underpriced back then.
Investing shock: Buffett was wrong
Buffett didn't buy Google. Sadly, neither did I -- a decision that has cost me thousands.
I held off on buying Google shares because they seemed expensive. I knew it owned the vast majority of the search market share, and had both a great corporate culture and innovative leaders. But I couldn't get past that lofty P/E ratio.
Instead, I was concentrating on buying poor companies on the cheap. These trash stocks, as I call them, have a nasty habit of getting even cheaper -- sometimes even going bust.
At least I'm not alone in buying "trash stocks." In his 1989 letter to Berkshire Hathaway shareholders, Buffett himself admitted to similar crimes. In a section of the letter called "Mistakes of the First Twenty-Five Years (A Condensed Version)," Buffett says he never should have bought control of the textile company Berkshire Hathaway.
Why? Even though he knew the textile manufacturing business Berkshire operated was in a declining industry, he was enticed to buy because the price looked cheap. While the Berkshire of today wouldn't exist without that original purchase, Buffett reluctantly closed the textile business in 1985.
Which reiterates a timeless Buffett-ism: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."
Value investing for suckers
I'm a great fan of Warren Buffett and like to think of myself as a value investor. But too often I've been guilty of buying those "trash stocks" -- cheap stocks with mediocre (or worse) businesses.
Although I've never owned them, over the years, I've come close to buying shares in State Street (NYSE: STT ) , Humana (NYSE: HUM ) , Xerox (NYSE: XRX ) , and even Time Warner (NYSE: TWX ) -- all of which appear relatively cheap, but operate in intensely competitive industries, and/or carry plenty of debt.
Nineteen years have passed since that famous 1989 letter to Berkshire Hathaway investors. As I review my portfolio today, I see fewer and fewer "trash stocks."
Through a combination of expensive errors, experience, and a commitment to continued investing education, I've slowly come to realize that the best long-term investments are in companies in growing industries that possess long-term, sustainable competitive advantages.
A heady combination of value and growth investing
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I wish you happy, trash-free investing.
This article was first published on March 7, 2008. It has been updated.
Bruce Jackson finds taking out the trash satisfying. He is a beneficial owner of Berkshire Hathaway shares and is short Google put options. The Motley Fool also owns shares of Berkshire Hathaway, a recommendation of Motley Fool Stock Advisor and Inside Value. Coca-Cola is also an Inside Value recommendation. Google is a Rule Breakers pick. The Motley Fool's disclosure policy is enlightening.