When Warren Buffett first took control of Berkshire Hathaway (NYSE:BRK-A), it was a struggling textile manufacturer. Rather than invest an incredible amount of additional capital in a vain attempt to keep that business competitive with cheaper offshore rivals, Buffett let it die off.

Instead of throwing good money after bad, Buffett used the cash the textile business generated in its dwindling days to invest elsewhere and diversify the company. That decision helped turn Berkshire into the insurance and investment giant it is today, and paved the way for Buffett to become a multibillionaire. It's a great story of his investing prowess and the benefits of intelligent capital allocation -- but it also helped accelerate the original Berkshire's demise.

Is history repeating itself?
Perhaps as a way of foreshadowing things to come, Eddie Lampert is often described as "the next Warren Buffett." A hedge fund manager, Lampert took control of the once-bankrupt K-Mart and used his financial prowess to leverage that investment in fellow retailer Sears. The resulting Sears Holdings (NASDAQ:SHLD) is a marriage of two struggling former titans, both of which are worth more to Lampert as asset plays than as retailers.

Both Sears and K-Mart own plenty of valuable real estate, bought decades ago and held on the books at depreciated historical cost. Even in today's real estate slump, Lampert can sell off those buildings and land to book profits and raise cash to invest elsewhere. In addition, while the combined company continues to struggle with accounting profitability, its operations still generate solid free cash flow.

And in Buffett-like fashion, Lampert is very concerned about overinvesting that cash in an existing business that's unlikely to provide a decent return. As a result, there's a very real chance that Lampert may do what Buffett did for Berkshire: doom Sears and K-Mart, the retailers, to save Sears Holdings, the overall company.

That shouldn't be a surprise. After all, both Lampert and Buffett are value-focused investors who care about a company's ability to generate cold, hard cash. The more, the merrier. And both those top-tier investors are even happier when that cash flow can be bought cheaply. After all, the less they need to invest to get that cash flow, the more productive their capital can be.

Invest like those market masters do
Cash flow is of such paramount importance to these greatest of capital allocators that they'd rather see a company's business line die than to invest in something that won't generate cash. If you want to follow in their investing footsteps, you too should make cash productivity a key metric you seek in the companies you're partially buying in the stock market.

Fortunately, it's fairly straightforward to find companies that generate significant amounts of cash. Just look for businesses with strong free cash flow (which is frequently measured by turning to the cash flow statement and subtracting capital expenditures from operating cash flow). It's an easy -- and critically important -- metric to measure, but because it's not typically reported by automated screening tools, it's one that's often overlooked.

And because free cash flow is so easily overlooked, you can often find companies trading at single-digit multiples to their realized cash-generating ability. Like these, for instance:


Market Capitalization
(in Millions)

Free Cash Flow
(in Millions)

Market Capitalization-to-Free Cash Flow Ratio

Pfizer (NYSE:PFE)












Honeywell (NYSE:HON)




Lockheed Martin (NYSE:LMT)




Data from Capital IQ.

As long as there are investors more concerned with accounting earnings than a business' true cash-generating capability, you will find chances to buy cash flow on the cheap. In so doing, you're following in the footsteps of some of the greatest investing minds of our time.

If it works for them ...
At Motley Fool Inside Value, we've seen just how successful investors like Buffett and Lampert have been, thanks to their laser-like focus on buying cash generation on the cheap. We're proud to have adopted their strategy as our own, and we've been sharing in some of their success as a result -- outperforming the S&P 500 by an average of eight percentage points per recommendation since the service's inception. If you're ready to join us in following the path those greats have blazed, click here to start your no obligation, 30-day free trial.

At the time of publication, Fool contributor Chuck Saletta did not own shares of any company mentioned in this article. Sears, Pfizer, and Berkshire Hathaway are Inside Value selections. Berkshire Hathaway is also a Motley Fool Stock Advisor pick. The Motley Fool owns shares of Berkshire Hathaway and has a disclosure policy.