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 income 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 the 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 latest batch of earnings brought money into the company, or merely disguised a cash hemorrhage with a pretty headline.
Calling all cash flows
It's worth checking up on your companies' free cash flow (FCF) 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 Coach
That means that Coach turned 29% of its revenue 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.
|
Company |
LTM Revenue |
TTM FCF |
TTM FCF Margin |
|---|---|---|---|
|
LVMH Moet Hennessy Louis Vuitton (OTC: LVMHF) |
$ 24,440 |
$3,133 |
12.8% |
|
Luxottica |
$ 6,996 |
$836 |
11.9% |
|
Estee Lauder |
$ 7,639 |
$962 |
12.6% |
|
Nordstrom |
$ 8,922 |
$897 |
10.0% |
|
Gap |
$ 14,399 |
$1,677 |
11.6% |
Among Coach's competitors and peers, LVMH comes in with the highest FCF margin (defined as FCF / trailing 12 months' revenue), with 12.8% of its revenues turning into FCF.
All cash is not equal
Unfortunately, the cash flow statement isn't immune from nonsense either. That's why it pays to take a close look at the components of free cash flow, 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 -- generally good stuff. But an increase in cash flow based on stiffing your suppliers (by increasing accounts payable) or stiffing Uncle Sam on taxes -- those 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 Coach look? Take a peek at the chart below, which flags questionable cash flow sources with a red bar.
I characterize as questionable those 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 its true cash profitability.
With questionable cash sources comprising 9% of the cash flow from operations for Coach, I'm not too worried, but it would be a good idea to keep an eye on this in the future.
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 Coach 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.
