Not Listening to Buffett Cost Me Thousands

News broke in February that Berkshire Hathaway (NYSE: BRK-B  ) chairman Warren Buffett was once again the richest man in the world. However, the very latest Forbes list has him back in second place again behind his mate Bill Gates. There's only a mere $7 billion in it, loose change for those guys, so by the time you read this he could easily be back on top again.

Regardless of that little battle, given that Buffett's estimated $50 billion fortune was amassed through investing acumen -- he's almost universally accepted as the world's greatest stock market investor -- it pays to listen when he talks.

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 that have strong competitive advantages, companies such as Johnson & Johnson, Coca-Cola, and Burlington Northern Santa Fe (NYSE: BNI  ) -- 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 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 August 2004 IPO, 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, was continuing to take market share, and had sustainable competitive advantages in its enterprising culture, superior advertising platform, and brand loyalty. Given its growth rate since and its powerful model, it was underpriced back then.

Investing shock: Buffett was wrong
Buffett didn't buy Google, but legendary value investor Bill Miller saw the value and scooped up shares. Sadly, I didn't -- a decision that has cost me thousands.

I didn't buy Google shares because they seemed expensive. I knew it had the vast majority of the market share in search, 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 going as far as 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 Nordstrom (NYSE: JWN  ) , The Gap (NYSE: GPS  ) , Texas Instruments (NYSE: TXN  ) , Advanced Micro Devices (NYSE: AMD  ) and NVIDIA (Nasdaq: NVDA  ) -- all of which appear relatively cheap, but which operate in intensely competitive industries.

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
If you need stock ideas today, there are more than a few such companies among our recommendations at Motley Fool Stock Advisor. I've known Fool co-founders and Stock Advisor advisors David and Tom for more than a decade now, and both are intelligent, business-focused investors.

Since the newsletter's inception in April 2002, their recommendations have outperformed the market by more than 42 percentage points. If you'd like to learn more about their latest stock picks and five favorite ideas for new money, give Stock Advisor a try free for the next 30 days.

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 proud owner of Berkshire Hathaway B shares; if you can't beat Buffett, join him. The Motley Fool owns shares of Berkshire Hathaway. Berkshire and The Gap are recommendations of both Inside Value and Stock Advisor. Coca-Cola is also an Inside Value recommendation. Google is a Rule Breakers pick. The Motley Fool's disclosure policy is enlightening.

Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 25, 2008, at 3:39 PM, fongfong200 wrote:

    The approach I take is continuously learning and continuously cleaning up.

  • Report this Comment On September 25, 2008, at 5:34 PM, manateeisland wrote:

    Not sure about the NVDA competiveness factor. Among PC gamers, NVDA technology is by far superior to ATI or Intel with their graphics quality and speed. There may be a few bumps in the road, but NVDA has the track record to keep my confidence about their ability to remain top dog. I don't think ATI or Intel will ever touch them. By the time ATI even seems to get close, NVDA usually is onto something even faster and of higher quality. Maybe the fools can view gamers using each of the brands and really understand the difference, as it is hard to comprehend until you do. I'd love to hear what you think of the differences.

  • Report this Comment On September 25, 2008, at 6:18 PM, Aurvandil wrote:

    ^ ATI currently has the performance lead(or at least the mind share of "gamers") with their 4850/4870 series. That doesn't matter though. What matters is that oem's are relying more and more on integrated graphics which are "just good enough" for the masses. Integrated graphics powered by intel. Sure AMD/ATI and Nvidia have their own integrated graphics solutions, but for various reasons they're not as popular as intel's.

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