You can always tell when Warren Buffett gets anxious.

At the end of 2007, his firm, Berkshire Hathaway (NYSE: BRK-A), was sitting on $44 billion in cash and investments. And that was too much money lying around, as far as he was concerned. So in 2008, he spent billions to acquire partial stakes in several blue chips firms such as General Electric  and Goldman Sachs.

Those buys pushed Berkshire’s cash balance down to a more reasonable $25 billion by the end of 2008. As Bloomberg News noted in October 2013, Buffett “likes to keep $20 billion on hand should the reinsurance operations need to pay large claims.”

If Buffett thought he was sitting on too much cash seven years ago, his troubles have grown larger. At the end of Q2 2014, Berkshire Hathaway held $55 billion in cash and investments — a company record.

Now, chatter is rising that Buffett is ready to plow that cash into another major acquisition.

At the end of the day, the main point is not which companies Buffett buys. Instead, it’s what constitutes a great acquisition. In effect, if such companies are good enough for Buffett, then they are good enough for the rest of us.

Chewing gum, Railroads, Lubricant and Ketchup

Buffett got his start buying insurance companies. However, he has since shown a willingness to venture into many kinds of industries — technology is the one sector he avoided, until recently.

Over the past six years, in addition to making quarterly investments in a range of publicly-traded companies, Berkshire has also swallowed up entire companies, including:

• Wrigley (in tandem with Mars) in 2008 for $23 billion
• Burlington Northern Santa Fe Corp for $26 billion in 2009
• Lubrizol for $9 billion in 2011
• H.J. Heinz (in tandem with 3G Capital) for $28 billion

All of these assets share the same traits. Wrigley and Heinz have strong brands. Burlington Northern and Lubrizol built wide moats around their business. And they all have a history of generating strong and growing free cash flow.

Buffett realizes that billions in cash parked in the bank yields minimal returns these days. So he needs to pursue deal-making if his firm is to keep garnering solid returns.

It’s notable that Berkshire is increasingly working with other investment firms to jointly acquire their prey. For example, Buffett’s firm announced plans this week for a $3 billion investment that will help Burger King (NYSE: BKW) acquire Canadian fast casual eatery Tim Horton’s. Even after that move, Berkshire Hathaway still has a war chest exceeding $50 billion.

To identify Buffett’s next acquisition target, I screened for U.S. companies that meet his criteria. Buffett rarely ventures outside the United States, perhaps for reasons of management oversight.

For starters, we can assume that Buffett likes to target companies that can be acquired for $5 to $25 billion. Around 400 companies in the S&P 400, 500 and 600 meet that threshold.

Second, these companies must have a history of strong free cash flow. From that universe of stocks, 166 companies generated positive free cash flow in 2013.

Lastly, Buffett likes bargains. He’ll likely only consider companies trading for less than ten times trailing free cash flow.

The results yield a group of stocks that Buffett was once known for: Financial services firms.

Source: ThomsonReuters

In light of Berkshire’s recent acquisition history, one might think that Buffett lost his appetite for financial services stocks. Buffett’s stakes in Wells Fargo and American Express are worth a combined $40 billion, and make up two of Berkshire’s top three public holdings, according to GuruFocus.com. The fact that these two firms sport a combined market value of $358 billion means that they are too large to own outright. But these other firms aren’t.

And the reason to own banks and insurers is about to get a lot more compelling. These firms hold considerable cash balances. That means an eventual uptick in interest rates will cause their interest income to soar. (Click here to read about other companies with massive cash balances.)

Let’s assume for a moment that Buffett believes that Berkshire already has ample exposure to the financial sector through its portfolio of privately-held and publicly-held stakes.

There are a handful of other companies in his preferred market value range, all of which trade at reasonable prices in relation to free cash flow. But with these companies you get what you pay for. All of them face growth headwinds, and Buffett’s team would need to find ways to invigorate sales or squeeze out costs to meet his goal of rising free cash flow.

Source: ThomsonReuters

Frankly, Buffett doesn’t like to fix other company’s messes. He prefers to buy companies with proven strong management teams, and the standout name in this group is Xerox Corporation (NYSE: XRX).  CEO Ursula Burns was dealt a tough hand when she took the reins of this photo-copy and fax machine firm in 2009. And in the face of clear headwinds, she has done an admirable job of transforming Xerox into a broader outsourcing and consulting firm. All the while, Xerox has generated at least $1.5 billion in free cash flow in three of the past four years.

To be sure, the kind of companies that Buffett really loves — those with strong brands or robust moats — can’t be had for attractive prices. The five-year bull market has led to a sharp increase in value for most of these firms. So if Buffett instead looks at high-quality companies worth less than 12 times trailing free cash flow, then you could include:

• Cardinal Health, Inc. (NYSE: CAH)
• C.R. Bard, Inc. (NYSE: BCR)
• Omnicom Group (NYSE: OMG)
• Rock-Tenn Company (NYSE: RKT)

Lastly, a pair of obvious choices already sits in Buffett’s portfolio. His firm has a $1.2 billion stake in building materials firm USG Corporation (NYSE: USG) and a $2.7 billion stake in dialysis firm DaVita HealthCare Partners, Inc. (NYSE: DVA), which means that Berkshire already owns 28% and 18% of those firms, respectively. The problem with acquiring companies in this fashion is that once Buffett starts to nibble, other investors bid up shares. DaVita, for example, has more than doubled in value since he began acquiring shares in late 2011.

Risks to Consider: Virtually every type of company that Buffett would seem likely to acquire has seen its value rise sharply in recent years, thanks to the extended bull market. Buffett, like Baupost Group’s legendary Seth Klarman, may choose to wait this market out and sit on cash until the next window of opportunity opens.

Action to Take –> Buffett has handily outperformed the broader market over the past 30 years by acquiring assets capable of generating robust and growing cash flow. Banks and insurers have economic tailwinds at their back for that to happen and, in relation to the rest of the market, appear reasonably priced. Don’t be surprised if Warren Buffett announces a major deal in this sector in coming quarters.

It’s safe to say, anything that Buffett buys, the average investor should also buy. But that’s easier said than done. How about a group of stocks that are so stable and profitable that you can buy them now, forget about them and reap the benefits forever. At StreetAuthority, we call them “Forever” stocks and we’ve found a treasure trove of them. To learn the name and ticker symbols of our Forever stocks, click here.