1 Thing Warren Buffett's Favorite Stocks All Have in Common

Warren Buffett is one of the greatest investors of all time, and there is one thing he always looks at before he makes an investment in a company.

Jan 25, 2014 at 11:20AM

When it comes to making an investment in a company, there is one thing Warren Buffett of Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) always looks to -- and it likely isn't what you think.

Insider Monkey

Source: Insider Monkey

One vital number
With earnings season in full swing, most investors will look to the top-line revenue number or bottom-line income to gauge how well or poorly the company did.

After all, almost all coverage of announcements will include some note about how well the earnings per share did relative to "analyst's estimates" to give some indication of the strength of the quarter.

And while those numbers are important to watch, there is one thing Buffett always looks to when he considers an investment or acquisition. And that is the company's ability to generate healthy, consistent, and predictable cash flows.

In his own words:

Our acquisition preferences run toward businesses that generate cash, not those that consume it [...] however attractive the earnings numbers, we remain leery of businesses that never seem able to convert such pretty numbers into no-strings-attached cash. 

Beyond earnings
Buffett undeniably comes from the Benjamin Graham school of value investing. So often people believe ideology only accounts for price to earnings and other similar valuation ratios, but Buffett almost throws all of those out the window, noting:

Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business. 

Consider for a moment Warren Buffett's second largest investment, Coca-Cola (NYSE:KO). If Buffett has held onto his 400 million shares -- which is an easy thing to assume considering he's said he'll "never sell," a share -- the market value of his Coca-Cola position would stand at $15.8 billion. Yet among the biggest companies, Coca-Cola isn't necessarily a compelling consideration from a traditional "value perspective" that focuses on P/E ratios.

A quick glance at the price-to-earnings ratio shows that Coca-Cola at 20.4 trades higher than both PepsiCo (19.3) and Dr Pepper Snapple Group (15.7). Coke's stock has looked "expensive" at times, but the business' ability to generate cash has kept Buffett from officially cashing in on his massive profits. 

Yet, when you consider the growth in its cash flow over the years, Coke has continually been growing its ability to generate cash year after year:

KO Cash from Operations (TTM) Chart

KO Cash from Operations (TTM) data by YCharts.

The takeaway
While Buffett's investment consideration of course goes beyond one simple number or metric, the purported value of a company is not simply a multiple of what it says it earns compared to its current price. Instead, investors need to see how those earnings translate to cash generation and the company's overall ability to return that cash to shareholders when making an investment consideration.

Although Coke may not pique the interest of many because of its valuation, it turns out when it comes to cash flow generation -- what Buffett will "run toward" -- it is indeed among the best. Whether its Coke, Procter & Gamble, or ExxonMobil, all three fit Buffett's bill and will likely be in the Berkshire portfolio for a long, long time. 

Buffet's best advice
Warren Buffett has made billions through his investing and truly understanding how to truly value a company. Yet the good news is, he wants you to be able to invest like him. Through the years, Buffett has offered up investing tips to shareholders of Berkshire Hathaway. Now you can tap into the best of Warren Buffett's wisdom in a new special report from The Motley Fool. Click here now for a free copy of this invaluable report.

Fool contributor Patrick Morris owns shares of Berkshire Hathaway, Coca-Cola, and ExxonMobil. The Motley Fool recommends Berkshire Hathaway, Coca-Cola, PepsiCo, and Procter & Gamble. The Motley Fool owns shares of Berkshire Hathaway, Coca-Cola, and PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers