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 Warren Buffett was standing by many of the banks in his portfolio -- namely Wells Fargo, US Bancorp (NYSE: USB), and M&T Bank (NYSE: MTB). 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' March lows, below $9 a share. Shares are hovering in the $20-$25 range 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 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 and trusting of Wells' management throughout the years. But even he doesn't know for sure what path the government bailout initiatives will ultimately take.

Now, am I calling his continued investment in Wells Fargo small-f foolish? My head shakes no. His expertise in all three areas I've mentioned exceeds that of most other investors. So while the remaining 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 my own top investments. 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:

Company	Moat
Wal-Mart	Scale
Johnson & Johnson (NYSE: JNJ)	Intellectual Property, Brand
Procter & Gamble (NYSE: PG)	Brand

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 gold star, let's look at some famous examples of companies whose moats aren't all they're cracked up to be.

Company	Moat
Apple	Network effects
Sears	Brand
Bank of America (NYSE: BAC)	Network effects/Scale

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 from Hewlett-Packard (NYSE: HPQ) and the rest. Only a few years ago, PDAs weren't phones, and the Palm Pilot was trouncing the Apple Newton. (Now Palm's new Pre is the underdog against Apple's iPhone.) Only a few years ago, Napster was relevant, and Apple's biggest digital music competitor, Amazon.com, was mostly just a bookstore competing with Barnes & Noble (NYSE: BKS).

As for Sears, value investors point to Sears' strong brand. I'd argue that the Sears brand is actually a negative, with less cachet than either Target or Wal-Mart.

I'll leave aside Bank of America's subprime problems for now. A bank's competitive advantage is largely measured on its net interest margin -- its ability to charge more interest on its loans than it pays for its capital. Wells Fargo's is a huge 4.8%. Bank of America's is a pedestrian 3%. Case closed.

I'm not necessarily saying Apple, Sears, and Bank of America are bad investments (heck, I own one of them). 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 with 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 only as part of a well-diversified portfolio.

Since we've been considering an extreme case, I've been purposely risk-averse in the three stocks I've mentioned. 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 their top five stocks for new money. Actually, they've done me one better, picking their top five on a risk-adjusted basis and their top five based on highest potential upside.