On Nov. 3, 2009, Warren Buffett bagged his elephant.

Last year's $44 billion buyout of Burlington Northern transformed Berkshire Hathaway into one of the nation's largest railroad barons. But it also fulfilled one of the Oracle's oldest promises: To put his company's enormous treasure trove to work.

A delightful dilemma
Berkshire Hathaway, you see, generates anywhere from $8 billion to $10 billion a year in cash -- cash that, as Buffett laments, just "piles up." Here at Motley Fool Stock Advisor, we think that generating too much free cash flow is an enviable situation, but for Buffett, it's always posed a problem. You see, unlike many of the companies he invests in, Berkshire does not itself pay any dividend at all.

With the dividend outlet firmly corked, Buffett has for years wrestled with the problem of how to put his vast profits to work effectively. That's a problem a lot of us wouldn't mind having, I suspect. But first, we have to make those profits.

Free cash flow: What is it?
At its simplest, "free cash flow" is the cash profit that a company has left over after paying its expenses. It is money the company can use to pay dividends to shareholders, build new factories and hire new workers, or simply sock away for a rainy day (or decade.) What free cash flow is most definitely not, though, is the "profits" that most Wall Street analysts focus on when deciding whether a company is a "buy," "sell," or "accumulate strongly with an option to hold."

An example may help to illustrate the concept. Consider a hypothetical company: Peoria Occidental Orthodontic Robotics (Ticker: POOR), a manufacturer of electric toothbrushes. Incorporated with $100 million in start-up capital in 2010, POOR embarks upon its business by pouring $100 million into building a toothbrush factory in Peoria, Ill. By 2019, POOR is selling $10 million worth of toothbrushes annually, toothbrushes that cost it $5 million to manufacture and sell.

POOR generates $5 million in annual cash flow. Because its factory has already been built, is highly automated, well-oiled, and so requires almost no maintenance, its capital expenditures are negligible. Thus, every year that POOR makes $10 million in sales, it deposits $5 million in the bank. So POOR's profitable, right?

Not according to Wall Street. You see, bright and shiny as it looks from the outside, POOR's accountants "depreciate" $10 million of the value of its factory every year for 10 years, to account for the initial expense of building it. As a result, at the same time as POOR is putting $5 million in the bank, it's telling the IRS, Wall Street, and pretty much everyone else who focuses on GAAP accounting, that it lost money for the year. And yet the company's bank account has been growing fatter and fatter with each passing year.

Free cash flow: Who's got it?
Now POOR is, of course, a fictional company (and really, any investment banker who let a company go public with a ticker symbol like this one would find himself flipping burgers at Mickey D's in short order.) But there are a whole lot of companies that offer the same rich investment opportunity in the real world, as POOR does in the imaginary.

Some of them look unprofitable, but are actually cash-rich; others look to be doing only "OK" under GAAP -- while behind the scenes, they're churning out gobs more cash than many people suspect:


Reported Earnings

Actual Free Cash Flow

Microsoft (Nasdaq: MSFT)

$17.3 billion

$20.3 billion


$11.9 billion

$16.5 billion

Pfizer (NYSE: PFE)

$8.6 billion

$15.4 billion

Research in Motion (Nasdaq: RIMM)

$2.4 billion

$2.9 billion

Dell (Nasdaq: DELL)

$1.4 billion

$3.5 billion

Data from Finviz.com and Capital IQ refer to trailing 12 month results.

Chalk it up to an abundance of caution, but personally I feel it's safer to invest in companies that generate cash in excess of what they report as earnings -- companies like POOR, and like those I've listed for you up above -- than in companies doing the opposite:


Reported Earnings

Actual Free Cash Flow

Advanced Micro Devices (NYSE: AMD)

$1.0 billion

$457 million

Visa (NYSE: V)

$2.7 billion

$471 million

Data from Finviz.com and Capital IQ refer to trailing 12 month results.

Which is not to say that such companies are dishonest ... I just tend to view the free cash flow figures as a more reliable indicator of what I'm looking for.

Buy when Wall Street won't
In contrast, at Motley Fool Stock Advisor we prefer to own stocks like POOR -- indeed, we already do own many stocks like it.

Why? In POOR's case, because things are going to change big time in 2020, when POOR's 10-year drought of GAAP profits will suddenly come to an end. After "depreciating" the final $10 million of its start-up factory costs, POOR will emerge into profitability. Its "losses" a thing of the past, all of a sudden, POOR will acquire a positive P/E ratio -- and a lot of professional investors will begin wondering whether that P/E ratio is low enough to make the stock a "buy."

Foolish investors, of course, knew that POOR was a rich investment all along. Because like the companies named above, and like Buffett's Berkshire, POOR suffered from the happy dilemma of making too much money.

The moral of the story
Wall Street's piled high with accounting degrees and CFAs. If it makes them happy to obsess over GAAP profits -- let 'em. Meanwhile, we'll just keep counting the cash.

Would you like to find a company like POOR in real life? Maybe one running the same kind of cash-rich business as the companies named above -- but at a more reasonable price? Sure you would. Grab yourself a free trial of Motley Fool Stock Advisor now, and we'll show you how.

Fool contributor Rich Smith does not own shares of any company named above. American Express, Microsoft, and Pfizer are Motley Fool Inside Value picks. Motley Fool Options has recommended a diagonal call position on Microsoft. Berkshire Hathaway is a Motley Fool Inside Value recommendation. Berkshire Hathaway is a Motley Fool Stock Advisor selection. The Fool owns shares of Berkshire Hathaway. The Fool has a disclosure policy.