Is This Cash Machine Running on Empty?

Although business headlines still tout earnings numbers, many investors have moved past net earnings as a measure of a company's economic output. That's because earnings are very often less trustworthy than cash flow, since earnings are more open to manipulation based on dubious judgment calls.

Earnings' unreliability is one of the reasons Foolish investors often flip straight past the income statement to check the cash flow statement. In general, by taking a close look at the cash moving in and out of the business, you can better understand 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
When you are trying to buy the market's best stocks, it's worth checking up on your companies' free cash flow (FCF) once a quarter or so, to see whether it bears any relationship to the net income in the headlines. That brings us to Sirius XM Radio (Nasdaq: SIRI  ) , whose recent revenue and earnings are plotted below.

Source: Capital IQ, a division of Standard & Poor's. Data is current as of last fully reported fiscal quarter. Dollar values in millions. FCF = free cash flow. FY = fiscal year. TTM = trailing 12 months.

Source: Capital IQ, a division of Standard & Poor's. Data is current as of last fully reported fiscal quarter. Dollar values in millions. FCF = free cash flow. FY = fiscal year. TTM = trailing 12 months.

Over the past 12 months, Sirius XM Radio generated $183.2 million cash on net income of $145.5 million. That means it turned 6.6% of its revenue into FCF. That sounds OK. Still, it always pays to compare that figure to sector and industry peers and competitors, to see how your company stacks up.

Company

TTM Revenue

TTM FCF

TTM FCF Margin

 Sirius XM Radio $2,757 $183 6.6%
 Walt Disney (NYSE: DIS  ) $38,188 $3,916 10.3%
 Time Warner (NYSE: TWX  ) $26,683 $2,403 9.0%
 Entravision Communications (NYSE: EVC  ) $198 $17 8.5%

Source: Capital IQ, a division of Standard & Poor's. Data is current as of last fully reported fiscal quarter. Dollar values in millions. FCF = free cash flow. TTM = trailing 12 months.

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 cash flow from operations, to make sure that the cash comes from high-quality sources. They need to be real and replicable in the upcoming quarters, rather than being 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 adjustments for non-cash income-statement expenses (like depreciation) is generally favorable. An increase in cash flow based on stiffing your suppliers (by increasing accounts payable) or shortchanging 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 Sirius XM Radio look? Take a peek at the chart below, which flags questionable cash flow sources with a red bar.

Source: Capital IQ, a division of Standard & Poor's. Data is current as of last fully reported fiscal quarter. Dollar values in millions. TTM = trailing 12 months.

Source: Capital IQ, a division of Standard & Poor's. Data is current as of last fully reported fiscal quarter. Dollar values in millions. TTM = trailing 12 months.

When I say "questionable cash flow sources," I mean items such as changes in taxes payable, tax benefits from stock options, and asset sales, among others. That's not to say that companies booking these as sources of cash flow are weak, or are engaging in any sort of wrongdoing, or that everything that comes up questionable in my graph is automatically bad news. But whenever a company is getting more than, say, 10% of its cash from operations from these dubious sources, investors ought to make sure to refer to the filings and dig in.

Sirius XM Radio's issue isn't questionable cash flow boosts, but items in that suspect group that reduced cash flow. Within the questionable cash flow figure -- here a negative-- plotted in the TTM period above, other operating activities (which can include deferred income taxes, pension charges, and other one-off items) constituted the biggest reversal. Overall, the biggest drag on FCF came from capital expenditures, which consumed 61.2% of cash from operations.

A Foolish final thought
Most investors don't keep tabs on their companies' cash flow. I think that's a mistake. If you take the time to read past the headlines and crack a filing now and then, you're in a much better position to spot potential trouble early. Better yet, you'll improve your odds of finding the underappreciated home-run stocks that provide the market's best returns.

We can help you keep tabs on your companies with My Watchlist, our free, personalized stock tracking service.

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. Walt Disney is a Motley Fool Inside Value pick. Walt Disney is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 09, 2010, at 3:13 PM, mlrinc10 wrote:

    Another 'jackwagon' analysis. Everyone knows Sirius XM's cash flow is finally increasing despite various conspiracies to halt this company, not the least by the FCC itself, short sellers and need I say MF itself. BTW, your comparisons to other companies in it's industry.......it's a monopoly, there are no comparisons. Geez!

  • Report this Comment On November 09, 2010, at 3:30 PM, Valuestocksonly wrote:

    Tricks for clicks. What a shame.

  • Report this Comment On November 09, 2010, at 3:44 PM, rockotodd2 wrote:

    actually they did claim SIRI was going BK and they were wrong

  • Report this Comment On November 09, 2010, at 4:42 PM, rouben45 wrote:

    Siri at this price is very good buying opportunity. SIRI is above 2.00$ by year end. Shorts can say what they want. You lost it guys and I am sorry for Ya.

    Vey Long on Siri and going longer.

  • Report this Comment On November 09, 2010, at 6:12 PM, yahoomania wrote:

    Seth Jayson.....yet another....Motley freaking loser!

  • Report this Comment On November 09, 2010, at 6:40 PM, winagain35 wrote:

    Ummm, isn't this a repost of an article from last month? Is this the type of "news" your subscribers pay for?

  • Report this Comment On November 09, 2010, at 10:56 PM, doubting wrote:

    What is your point? Siri reports less cash than it actually makes? Good for us. they will beable to a lot of greta things with this extra cash. Siri is not paying taxes? Siri will not pay taxes for a long time due to over $8B NOL. The bottom line is how much cash siri is going to have in the bank at the end of the year. Over $500M. Why don't you talk about that? Why do you guys keep taking us for a bunch of imbeciles by telling us how dubious their cash sources may be or that the company stock will be worth $2.50 at the end of 2014. I am amazed at your naivite considering that we will take your so called writings at face value. Sirius XM is a radio giant that has something that nobody has - infrastructure and content. Name me any company in radio that could boast that. NONE!!! That is their key to success. They are just getting started and those who will have enough patience and common sense to ignore your background noise stand to make a lot of money. In three years this will be a $40B company no matter how hard you try misinform the community!!!

  • Report this Comment On November 10, 2010, at 10:47 AM, mbl1234 wrote:

    "Sirius XM is a radio giant that has something that nobody has - infrastructure and content."

    It's also just a RADIO company. Radio is a limited technology, and it's easily duplicated these days on wifi.

    "In three years this will be a $40B company"

    OK, so bigger than Altria, bigger than Colgate, almost as big as Home Depot, coming up on Disney. You're insane and should stay away from sharp objects. it's people like you that make me think this will become a great company to short, if the loons that keep bidding this up have this kind of grasp on reality.

  • Report this Comment On November 11, 2010, at 8:56 AM, doubting wrote:

    mbl1234,

    Yes, bigger than Altria, Colgate, Home Depot. You are a demagogue who has no clue about this stock. It is simply a waste of time to even read your bright nonsense based on the fact that you have not written a single positive word about the stock. Sirius is a virtual MONOPOLY and you need to drive this deep into the few curvitures in your brain. And monopolies like IBM, Microsoft, Apple in their prime times are invaluable. Sirius is two or three years away from its prime time. $40B valuation in 2014 is still a very modest valuation.

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