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 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 (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 YRC Worldwide (Nasdaq: YRCW ) , which has produced -$292 million in FCF over the trailing 12 months, compared to -$622 million in net income. Those are a couple of pretty big negative numbers. About the best you can say is that at least the actual cash drain was smaller than the accounting loss.
That means that YRC Worldwide turned -6% of its revenue into FCF, or rather, it burned all that revenue, then burned some more cash. That's none too impressive. But it always pays to compare that figure to sector and industry peers and competitors, to see how your company stacks up.
|
Company
|
Revenue (TTM)
|
FCF (TTM)
|
FCF Margin (TTM)
|
|
Ryder System (NYSE: R )
|
$4,933
|
$372
|
8%
|
|
United Parcel Service (NYSE: UPS )
|
$46,087
|
$3,135
|
7%
|
|
Expeditors International of Washington (Nasdaq: EXPD )
|
$4,381
|
$252
|
6%
|
|
C.H. Robinson Worldwide (Nasdaq: CHRW )
|
$7,964
|
$291
|
4%
|
|
Werner Enterprises
|
$1,697
|
$56
|
3%
|
|
Con-way (NYSE: CNW )
|
$4,468
|
$140
|
3%
|
|
FedEx (NYSE: FDX )
|
$34,734
|
$322
|
1%
|
TTM = trailing 12 months.
Among YRC's competitors and peers, Ryder System comes in with the highest FCF margin (defined as FCF / trailing 12 months' revenue), with 8% of its revenue turning into FCF. I've long been skeptical of FedEx as an investment, because its FCF production is so low -- currently 1%.
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 YRC Worldwide 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 the true cash profitability.
In this case, the items which can sometimes represent questionable cash benefits are actually draining cash from YRC Worldwide, so shareholders ought to wonder why. Turns out, shifts in taxes and losses on debt redemption were responsible for much of the recent shift. However, it's worth taking a second look at that graph, especially the capital expenditures bar (brown). See how it shrivels down to nearly nothing in the recent periods? Were it to remain congruous to previous years, the cash burn would have been a lot worse. Seems that at YRC, there's plenty to worry about.
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 YRC Worldwide 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.
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