You Don't Know Warren Buffett
Think you know how the world's greatest investor rolls? You don't know Warren!
Matt Koppenheffer
THE MOTLEY FOOL — 12/03/09

Berkshire Hathaway (Symbol : BRK/A)'s Warren Buffett is a value investor, right? Everyone knows that!

Well, don't tell that to Gerald Martin and John Puthenpurackal of American University and UNLV. In 2008, the two completed what they call "the first rigorous examination of Berkshire Hathaway's (Symbol :
BRK/A) investment performance" -- a paper that analyzed not only the superior investment performance of Buffett, but also looked at his investing style.

Besides concluding that Buffett's superior investment returns since 1976 were more than just luck -- as if we didn't know that already! -- Martin and Puthenpurackal concluded that Warren Buffett is ... wait for it ... a large-cap growth investor.

The definition of growth that the researchers used separates value and growth stocks based on the inverse of book value multiples.

It classifies value stocks as those with the highest book-to-market ratio, and pegs those with the lowest as growth stocks.

According to the paper, growth stocks accounted for more than 40% of Berkshire's investments, while true value picks made up less than 20% of Buffett's buys.

But let's not get too crazy here. After all, Buffett is still very much a value investor by his own definition.

That is, he only buys stocks that offer a discount to the company's intrinsic value. Still, this study does suggest that if we're looking for Buffett-esque stocks, our best bet is to look for high-quality companies, rather than rummaging through the bargain bin.

To track down stocks that might fit the bill, I've enlisted the help of The Motley Fool's CAPS community and its stock screener.

I focused my search on stocks that are returning 10% or more on their equity, are trading above book value, and have earned high ratings from CAPS community members. (You can run the same screen by clicking here.)

Company
Return on Equity (TTM)
Book Value Multiple
CAPS Rating
(out of 5)

Rio Tinto (NYSE: RTP)
17.8%
2.6
*****

Kroger
22.3%
2.6
****

Costco (Nasdaq: COST)
10.8%
2.6
****

Massey Energy (NYSE: MEE)
11.0%
2.7
****

Schlumberger (NYSE: SLB)
18.1%
4.0
*****


Source: CAPS as of Dec. 2. TTM = trailing 12 months.

While these aren't meant to be formal recommendations, they're a great place to kick off more research. In fact, why don't we start by taking a closer look at Motley Fool Stock Advisor pick Costco?

How strong is your moat?

In most cases, the argument for paying a premium price for a stock is that the company has, as Buffett would say, a strong "moat" around it.

That is, the company has some sort of competitive advantage that protects its margins, growth opportunities, or both.

In Costco's case, that moat would likely be the company's scale -- its size and ability to keep prices low -- and its membership model.

The warehouse chain concept is built around the idea that profit growth will ensue if you keep prices low, woo new members, encourage high-volume buying, and maintain operational efficiencies.

As the third-largest retailer in the U.S. and the ninth largest worldwide, scale certainly helps Costco. However, the company does face tough competition from other retail giants such as Wal-Mart Stores (Symbol : WMT) and Target , as well as traditional grocers and online retailers like Amazon.com (
Symbol :
AMZN) . So we should expect Costco to have to really slug it out to maintain its size and pricing advantages.

Though the membership warehouse model isn't unique -- both Wal-Mart's (Symbol : WMT)Sam's Club and

BJ's Wholesale provide direct competition -- this may be an even more interesting advantage for Costco.

While the company earns a slim 10.8% gross margin on its product sales, the membership fees -- which totaled $1.5 billion in its 2009 fiscal year -- provide a steady stream of extremely high-margin income. 

This gives Costco's bottom line a distinct advantage over traditional retailers.

CAPS or bust
We don't have to wonder whether Buffett would find an attractive moat in Costco's stock. Berkshire Hathaway (Symbol : BRK/A) already owns $320 million in Costco stock, which is about 1.2% of outstanding
shares. But he's not the only one who appreciates Costco. More than 3,400 CAPS members have given the stock a thumbs-up.

Last month, CAPS member Hydpdx became one of the Costco bulls, highlighting membership fees:

Great business model. Very low margin on the actual goods sold - great value for the customers/members. Almost the entire income is from membership dues.

Hard to beat that the solid reputation they have.

But here's the real question: What do you think of Costco's prospects?

Let the CAPS community know by clicking over and sharing your opinion with the 145,000 investors already participating.

Costco pays a modest dividend, but if you're really looking to rake in dividends, check out Todd Wenning's five stocks for growth and income.