1/

Get a cup of coffee.

In this thread, I'll walk you through the basics of Capital Allocation.

The better we understand how capital moves in and out of a business, the better we can predict the business's future cash flows and its stock's long-term performance.

2/

Businesses generate *cash* through their operations.

For example, Apple generates cash by selling iPhones.

Starbucks generates cash by selling coffee.

Google generates cash by selling ads.

IBM generates cash by doing things I don't understand.

Etc.

3/

Capital Allocation is the step that comes *after* generating all this cash.

That is, once the cash is available, what does the CEO *do* with it?

What projects does he invest in? What acquisitions does he make? Does he return any cash back to shareholders? Etc.

4/

Capital Allocation can make a tremendous difference to a company and its shareholders.

For example, at Berkshire Hathaway, Buffett took the cash generated by textiles and allocated it towards operations that produced much higher returns. Like insurance and candy.

5/

This transformed Berkshire Hathaway from a lowly bunch of textile mills to the super successful giant diversified conglomerate that it is today.

Along the way, long term shareholders reaped rich rewards.

That's *good* Capital Allocation.