Do You Trust the Earnings at Ford Motor?

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 Ford Motor (NYSE: F  ) , 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.

Over the past 12 months, Ford Motor generated $7,385.0 million cash on net income of $6,561.0 million. That means it turned 5.7% of its revenue into FCF. That sounds OK. Since a single-company snapshot doesn't offer much context, it always pays to compare that figure to sector and industry peers and competitors, to see how your business stacks up.

Company

TTM Revenue

TTM FCF

TTM FCF Margin

 Ford Motor $128,954 $7,385 5.7%
 Toyota Motor (NYSE: TM  ) $241,968 $3,497 1.4%
 General Motors (NYSE: GM  ) $135,142 $2,331 1.7%
 Honda Motor (NYSE: HMC  ) $110,968 $666 0.6%

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 Ford Motor 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.

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 questionable cash flows amounting to only 1.2% of operating cash flow, Ford Motor's cash flows look clean. Within the questionable cash flow figure plotted in the TTM period above, other operating activities (which can include deferred income taxes, pension charges, and other one-off items) provided the biggest boost, at 5.1% of cash flow from operations. Overall, the biggest drag on FCF came from capital expenditures, which consumed 35.7% 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. General Motors is a Motley Fool Inside Value selection. Ford Motor is a Motley Fool Stock Advisor selection. The Fool owns shares of Ford Motor. 

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 (4) | Recommend This Article (13)

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 March 07, 2011, at 10:45 AM, danielleaders wrote:

    I trust Ford more than I would G.M. GM talks about profits . But they still owe billions to the taxpayers . When they paid that back then they can say they are making profits I feel RAPED by this company . GO FORD

  • Report this Comment On March 07, 2011, at 10:50 AM, thokline wrote:

    Interesting article. Too technical for me, so I could not

    draw a conclusion to your negative title.

    The shorts are all over Ford and I don't think a title to

    your analysis of "do you trust..." helps.

    If you think there is a problem - fine , but I didn't get that from the piece. In fact what made it worse was

    lack of clarity as your conclusions. Actually sounded

    positive to this reader.

    You aren't shorting the stock are you? Just

    happens it is in a nice free fall at the present and a

    title like "do you trust Ford's Earnings" will grab

    attention. Many never read the article. Titles, as

    any journalist knows are powerful stuff.

    Thomas F. Kline

    Raleigh NC

    919-521-8698

  • Report this Comment On March 07, 2011, at 11:13 AM, HOGridin wrote:

    I understand Ford to now have a large (>$10--Bln) benefit to put on the books from paper reserves held back to pay taxes on profits that never materialized. GM has been able to carry forward through bankruptcy over double Ford's amount of tax write-offs against future profits, (GM's bankruptcy just keeps taking away from the tax payer doesn't it?)

    The article makes several good points and when examining Ford in ligh tof them, I am still long on Ford. A similar analysis of GM by the author would prove very enlightening.

    With Arab oil, Libiya, et al .. I feel Ford is still best suited with a huge line up of fresh actual gas & energy stingy cars, not hype like the Volt which has a range of 22-28 miles in cold weather. I guess the design engineers didn't live in Michigan?? I know it gets cold there!

  • Report this Comment On March 07, 2011, at 12:50 PM, BuyemHoldem wrote:

    Alan Mulally for President (of the USA)

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1453621, ~/Articles/ArticleHandler.aspx, 10/23/2014 9:55:15 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement