Earlier this year, Forbes ranked Berkshire Hathaway (NYSE: BRK-B ) Chairman Warren Buffett as the second-richest man in the world, with an estimated net worth of $37 billion. While his net worth had dropped by a cool $25 billion over the preceding 12 months, it's still an impressive haul.
Although some people have recently questioned his judgment, Buffett is still almost universally accepted as one of the world's greatest stock market investors. When he talks, it pays to listen.
The Oracle is commonly considered a value investor, but he seems just as focused on growth. Either way, he has proved 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 Coca-Cola, ExxonMobil (NYSE: XOM ) , Wal-Mart (NYSE: WMT ) and recent acquisition Burlington Northern Santa Fe (NYSE: BNI ) , all current Berkshire investments.
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: "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 rapidly, continuing to take market share, and building sustainable competitive advantages in its enterprising culture, superior advertising platform, and brand loyalty. Given its growth rate ever 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 -- and 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 that the textile-manufacturing business Berkshire operated was part of a declining industry, he was enticed to buy because the price looked cheap. The Berkshire of today wouldn't exist without that original purchase, but Buffett reluctantly closed the textile business in 1985.
And that brings to mind 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 Boeing (NYSE: BA ) , Wynn Resorts (NYSE: WYNN ) and even AIG (NYSE: AIG ) -- all of which appeared relatively cheap but operate in intensely competitive industries and/or carry plenty of debt.
Twenty 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 March 7, 2008. It has been updated.
Bruce Jackson finds taking out the trash satisfying. He is a beneficial owner of Berkshire Hathaway shares. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. Google is a Rule Breakers selection. Berkshire Hathaway, Wal-Mart and Coca-Cola are Inside Value recommendations. Coke is also an Income Investor pick. The Fool owns shares of Berkshire Hathaway, and its disclosure policy is enlightening.