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Why Advanced Micro Devices' Earnings Aren't So Hot

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 once a quarter or so, to see whether it bears any relationship to the net income in the headlines. That brings us to Advanced Micro Devices (NYSE: AMD  ) , whose recent revenue and earnings are plotted below.

Source: Capital IQ, a division of Standard & Poor's. Data are 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, Advanced Micro Devices generated $668 million cash on net income of $1,296 million. That means it turned 10.3% of its revenue into FCF. That sounds pretty impressive. Still, it always pays to compare that figure to sector and industry peers and competitors, to see how your company stacks up.


TTM Revenue


TTM FCF Margin

 Advanced Micro Devices $6,491 $668 10.3%
 Intel (Nasdaq: INTC  ) $42,735 $10,128 23.7%
 Silicon Image (Nasdaq: SIMG  ) $175 $33 19.0%
 Sigma Designs (Nasdaq: SIGM  ) $242 $21 8.5%

Source: Capital IQ, a division of Standard & Poor's. Data are 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 AMD 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 are 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.

With 30.2% of operating cash flow coming from questionable sources, AMD investors should take a closer look at the underlying numbers. Within the questionable cash flow figure plotted in the TTM period above, stock-based compensation and related tax benefits provided the biggest boost, at 8.7% of cash flow from operations. Overall, the biggest drag on FCF came from changes in accounts receivable, which consumed all of cash from operations, and more besides. Advanced Micro Devices investors may also want to keep an eye on accounts receivable, because the TTM change is 2.7 times greater the average swing over the past five fiscal years.

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. Intel is a Motley Fool Inside Value pick. Sigma is a Motley Fool Rule Breakers recommendation. The Fool owns shares of and has bought calls on Intel. Motley Fool Options has recommended buying calls on Intel. 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 (3) | Recommend This Article (2)

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 December 01, 2010, at 1:28 PM, MnAdude wrote:

    seth, is right, cash is king and is the focus of all my private equity clients. Note that stock comp is really an add back to derive cash from ops, but the principal he is driving at is absolutely correct - you need to identify and isolate nonrecurring/one-time sources of cash.

    Also a good point that net income and cash from ops should not be dramatically different over the long run. Sometime, check out the glaring disparity in cash from ops versus earnings in Enron's old SEC filings that most investors chose to ignore.

  • Report this Comment On December 01, 2010, at 8:06 PM, rav55 wrote:

    Actually AMD's earnings aren't bad. And looking forward into the release of revolutionary new products is pretty good.

    Especially if MicroSoft uses AMD in the latest XBOX as discussed here:

  • Report this Comment On December 03, 2010, at 10:12 AM, Kupitero wrote:

    Motley Fool is probably run by talented but book-bent writers.

    Books are for reading but applying all those idealistic sceneries in the books don't cut it in real life.

    I've seen a lot of brilliant boys who ends up por because they're too bookish.

    This writer is no different....just cut the crap and trade.

    I've seen all these 'professorial rants' that trashes AMD' but..sorry, no impact on the stock's price.

    Real-life bottom line: This writer is a sore AMD short.

    That's the truth.

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