Not Listening to Buffett Cost Me Thousands

It was announced in February that Berkshire Hathaway chairman Warren Buffett was again the richest man in the world. Given that his estimated $62 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 to be 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 Coca-Cola, Washington Post, Kraft Foods, Anheuser-Busch (NYSE: BUD) and Johnson & Johnson -- all current Berkshire holdings.

Coca-Cola, for instance, was called by one Wall Street analyst "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 (Nasdaq: GOOG) 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 Gannett (NYSE: GCI), Cadence Design Systems (Nasdaq: CDNS), Qwest Communications (NYSE: Q), Manpower (NYSE: MAN) and Whirlpool (NYSE: WHR) -- 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
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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 putting trash in the trash satisfying. He is a proud owner of Berkshire Hathaway B shares, going by the philosophy: If you can't beat Buffett, join him. The Motley Fool owns shares of Berkshire Hathaway. Berkshire is a recommendation of both Inside Value and Stock Advisor. Coca-Cola is also an Inside Value recommendation. Anheuser-Busch is a former Inside Value selection. Johnson & Johnson and Kraft are Income Investor selections. Google is a Rule Breakers pick. The Motley Fool's disclosure policy is enlightening.