Show Me the Money, Altria

Although headlines still spray earnings figures all over the media every day, many investors have moved past net earnings as a measure of a company's economic output. That's because an earnings statement is very often less trustworthy than a cash flow statement, because it's more open to manipulation based on dubious judgment calls.

The unreliability of the income statement is one of the reasons Foolish investors often flip straight past the income statement and balance sheet to eyeball the cash flow statement. In general, by taking a close look at the cash moving in and out of the business, you can get a better look at whether the last batch of earnings brought money into the company, or merely disguised a cash gusher with a pretty headline.

Calling all cash flows
It's worth checking up on your companies' free cash flow once a quarter or so, to see if it bears any relationship to the net income in the headlines. That's what brings us to Altria (NYSE: MO), which has produced $3,173 million in FCF in the 12 months through March, compared to $3,430 million in net income.

That means that Altria turned 19% of its revenues into FCF. That looks amazing. But, it always pays to compare that figure to sector and industry peers and competitors, to see how your company stacks up.

Among its competitors and peers, Lorillard comes in with the highest FCF margin (defined as FCF / trailing 12 months' revenue), with 31% of its revenues turning into FCF. With Reynolds at 15%, Altria is comfortably in the middle of the range.

All cash is not equal
Unfortunately, the cash flow statement isn't immune from nonsense. That's why it pays to take a close look at the components of free cash flow from operations, to make sure that these sources of cash are of good quality: In other words, that they're real, and replicable, in the upcoming quarters and not offset by continual cash outflows that don't appear on the income statement (such as major capital expenditures). For instance, cash flow based on cash net income and predictable depreciation is generally good stuff. But an increase in cash flow based on stiffing your suppliers (by increasing accounts payable) or stiffing Uncle Sam on taxes will come back to bite investors later. The same goes for decreasing accounts receivable. This is good to see, but it's ordinary in recessionary times, and you can only increase collections so much.

So, how does the cash flow at Altria look? Take a peek at the chart below, which flags questionable cash flow sources with a red bar.

I characterize as questionable cash flow statement line items such as changes in taxes payable, tax benefits from stock options, asset sales, and other items. That's not to say that companies booking these as sources of cash flow are weak or are engaging in any sort of wrongdoing. But whenever a company is getting more than, say, 10% of its cash from operations from these questionable sources, I feel obliged to crack open the filings and dig even deeper to make sure I am in touch with the true cash profitability.

With questionable cash sources comprising -13% of the cash flow from operations for Altria Group, we don't need to worry about a boost to FCF, but we might want to know what the reductions are all about. The majority comes from adjusting equity investment increases (which can boost net earnings, but don't bring any cash). Altria's cash flows look very clean.

Foolish final thought
If you are the kind of investor who takes the time to read past the headlines and crack a filing now and then, you're probably ahead of 95% of the rest of the individual investors out there. By keeping an eye on the health of your companies' cash flow, you can spot potential trouble early, or figure out if Mr. Market's pessimism is warranted by the numbers. Let us know what you think of the health of the cash flows at Altria Group in the comments box below. Or, if you're itching to learn more, head on over to our quotes page to view the filings directly.