Buffett's Wrong: 3 Companies That Beat His

My jaw hit my chest when I heard it.

I sat dumbfounded at Buffett-Fest '09, otherwise known as the Berkshire Hathaway annual meeting. As one of 35,000 value investors who trekked to Omaha, Neb., in early May 2009 to hear the wisdom of Warren Buffett, I nodded my head along with the rest of the crowd for most of the day.

Judge a company by value, not stock price. Nod. America will recover from this financial crisis. Nod. Derivatives are bad. Nod. Wells Fargo is the best stock in the world to go all in on. Huh?

I knew that Buffett was standing by many of the banks in his portfolio -- namely Wells Fargo, US Bancorp, and M&T Bank. So I wasn't all that surprised when he said that "[Berkshire] would buy stock in any of the three at current prices."

But Buffett took it oh so much further: "If I had to put all of my net worth into one stock, that would be the stock."

The caveat? He was referring to Wells Fargo's March lows, below $9 a share. Shares are in the high $20s at present, so Buffett probably wouldn't be quite so emphatic now.

But still!
I'll buy that Wells Fargo had tremendous upside potential in the single digits (some argue it still does), but the possible downside precludes me from naming Wells Fargo my "if-I-had-to-go-all-in" stock.

As I've said in the past, before it's wise to invest in a bank, you need three things:

• Particular insight into bank balance sheets.
• An unshakable faith in that bank's management.
• Comfort in speculating on the final form of the government bailout and regulatory initiatives.

With the possible exception of a handful of Wells Fargo employees, no one knows Wells Fargo's balance sheet as well as Warren Buffett. And Buffett has grown very familiar with and trusting of the company's management throughout the years. But even he doesn't know for sure what path the government bailout and regulatory initiatives will ultimately take.

Now, am I calling his continued investment in Wells Fargo small-f foolish? My head shakes no. Buffett's expertise in all three areas I've mentioned exceeds that of most other investors. So while the lingering uncertainty surrounding the government's role in banking has me disagreeing with Buffett's extreme statement, I don't think he's foolish to invest a portion of Berkshire's money there.

However, I will turn to his investing prowess to find alternatives. Here are three companies Buffett owns that I'd choose over Wells Fargo as an all-in stock -- even at their current not-quite-bargain-basement prices. These three all have products that will still be in demand decades from now, and they have no need for government support:

You'll notice that Berkshire has significant holdings in all three of these companies. Wells Fargo isn't even the safest bet in his own portfolio!

Three crossable moats
Just so you don't think I'll give any company with a moat a gold star, let's look at some famous examples of companies whose moats aren't all they're cracked up to be.

Don't get me wrong: Apple is an amazing company. It has computers for which it can command a premium price, the hottest phone on the market, and a claim as the No. 1 music retailer in the U.S. (surpassing Wal-Mart last year).

Pretty formidable, but all of those advantages can be breached quite quickly by competitors -- just as Apple breached its competitors' advantages with surprising speed.

Remember, only a few years ago, MBA students were studying how IBM won the computer battle because it allowed PC clones to be built by Hewlett-Packard and the rest. Only a few years ago, Nokia (NYSE:NOK) or Motorola (NYSE:MOT) popped to mind when you thought "phone."

Now? The smartphones of Apple or Research In Motion (NASDAQ:RIMM) are top of mind. And a nanosecond ago, Napster was relevant, and Apple's biggest digital music competitor, Amazon.com, was mostly just a bookstore competing with the likes of Borders (NYSE:BGP).

Meanwhile, Goldman Sachs and JPMorgan Chase (NYSE:JPM) have been the darlings of Wall Street, capitalizing on weaker competition (bye-bye Bear Stearns and Lehman Brothers) and favorable interest-rate conditions to tear it up on the trading floor. Never learning the lessons of the financial crisis, these banks are still playing with a fire their moats may not contain. Remember, "too big to fail" doesn't mean "too big to underperform."

Even Buffett and Charlie Munger have marveled at Google's moat. What they found especially remarkable was how quickly that moat was created. A decade ago, Google's moat was a puddle. But in that decade, it relegated competitors like AltaVista and Lycos (and in a less direct way, Time Warner's (NYSE:TWX) AOL) to the dusty sections of our mental libraries. Just as Google went from zero to 60 in about a decade, so, too, could the mythical guy in his mother's basement. Respect Google's moat, but don't over-respect it.

Apple, Goldman Sachs, and Google aren't necessarily bad investments at the right price; I'm simply arguing that their moats aren't as strong as some would have you believe.

The all-in gambit
Establishing a wide, sustainable moat is a rare thing. Just so we're clear, even if you identify a company that has one, it's never a good idea to put all your money into one stock (even if that stock is Berkshire Hathaway). And if Wells Fargo falls back into single digits, don't go overboard taking Buffett's statement to its logical extremes. All the stocks I've mentioned should be researched thoroughly, and used as only part of a well-diversified portfolio.

Since we've been considering an extreme case, I've been purposely risk-averse in presenting the three stocks I'd choose over Wells Fargo. Though certainly not without risk, all of my candidates let you sleep pretty well at night. My fellow Fools over at our Inside Value newsletter service have performed a similar exercise, singling out a handful of stocks they feel can form the core of a successful portfolio. Actually, they've done me one better, picking their core choices and the best stocks for new money now.

Unlike Buffett, they don't have Wells Fargo on the latter list -- but another financial company did make the cut. If you'd like to see two stocks they like right now, click here for a free report.

This article was originally published May 6, 2009. It has been updated.

Anand Chokkavelu owns shares of Berkshire Hathaway. He tries his hardest not to go all in before the flop with a pair of queens. Google is a Motley Fool Rule Breakers selection. Berkshire Hathaway, Amazon, and Apple are Stock Advisor recommendations. Berkshire Hathaway, Wal-Mart, and Nokia are Inside Value selections. Johnson & Johnson and Procter & Gamble are Income Investor selections. The Fool owns shares of Procter & Gamble and Berkshire Hathaway. The Fool has a disclosure policy.