The importance of investing in businesses the produce consistent cash flow

Warren Buffett’s roots are in the manufacturing industry. Throughout his career, he’s invested in dozens of different manufacturing companies, from clothing manufacturers like

Fruit of the Loom to brick manufacturers like Acme Brick. In fact, his company Berkshire Hathaway was a textile manufacturer before it was an investment firm.

Warren Buffett was once researching Ford, one of the Big 3 automotive manufacturers. You would expect it to be a piece of cake for him. After all, he’d researched hundreds of manufacturers before, so it shouldn’t be too complicated to research another one.

But here’s the thing.

He said that he “couldn’t understand” Ford.

Huh?

Warren Buffett couldn’t understand The Ford Motor Company? What made Ford so much more complicated than any other manufacturer?

Predictability.

All the other manufacturers he invested in generated the same amount of free cash flow every single year. For example, Fruit of the Loom perhaps generated $3.3 billion in 2016, $3.5 billion in 2017, and $3.7 billion in 2018.

So, it was very easy to predict how much money it would make in the future.

By contrast, Ford wasn’t predictable at all. Just look at its incredibly volatile free cash flows:

2020—$3.0 billion of free cash flow

2021—$8.2 billion of free cash flow

2022—$946 million of free cash flow

2023— -$2.4 billion of free cash flow

That leads us to an important principle: only invest in companies that produce predictable free cash flow.

You can guess how much money Fruit of the Loom will make in the future based on stable past trends. But you can’t do the same thing for Ford.

Successful investing is about investing in a company that will earn lots of free cash flow relative to its purchase price. But if a company’s free cash flows are volatile like Ford, it’s hard to

predict how much free cash flow it will earn.

Thus, volatile free cash flows should be an immediate pass.