Berkshire Hathaway Inc. (BRK.A), The Gap Inc. (GPS): Use This Rule Of Thumb Before You Buy Another Share

International Business Machines Corp. (NYSE:IBM) is also a strong proponent of the use in FCF. Big Blue never uses EBITDA, and focuses solely on the cash flow. According to its 2012 annual report:

“International Business Machines Corp. (NYSE:IBM) has consistently generated strong cash flow, a key indicator of real business performance. In 2012 our free cash flow was $18.2 billion, a record for International Business Machines Corp. (NYSE:IBM) and $12 billion higher than a decade ago. We ended 2012 with $11.1 billion of cash and marketable securities.”

Not surprisingly, Buffett’s Berkshire Hathaway Inc. (NYSE:BRK.A) emphasizes cash flow and refrains from any use of EBITDA. If you go through all of Berkshire Hathaway Inc. (NYSE:BRK.A)’s annual reports dating back to the 1970s, you won’t find the term EBITDA used in the context of business valuation. Instead, you will see a strong focus on “owners earnings,” which are a form of cash earnings. Specifically, Buffett repeatedly stated that trumpeting EBITDA is a particularly pernicious practice. In the year 2012 alone, Berkshire Hathaway Inc. (NYSE:BRK.A) generated $20.95 billion of free cash flow. This compares to $20.4 billion and $17.9 billion in the years 2011 and 2010, respectively.

Again, it’s my belief that only a company which knows how to truly evaluate its stream of cash flow, can also increase it substantially, like Berkshire Hathaway Inc. (NYSE:BRK.A) has been doing over the years.

My rule of thumb to investing

Financial reporting is the only mirror through which we can view the insides of a corporation. There’s simply no other way. And that’s why it’s crucial to pick and choose the companies with the sharpest and cleanest glass mirrors. By choosing to invest only in companies that employ free-cash- flow metric and refrain from EBITDA, you’re already ahead of 90% of investors out there. That’s a great place to be.

The article Use This Rule Of Thumb Before You Buy Another Share originally appeared on Fool.com and is written by Shmulik Karpf.

Shmulik Karpf has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway and International Business Machines. Shmulik is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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