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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 Enterprise Products Partners (NYSE: EPD  ) , 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, Enterprise Products Partners generated $259.2 million cash on net income of $320.8 million. That means it turned 0.8% of its revenue into FCF. That doesn't sound so great. 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.


TTM Revenue


TTM FCF Margin

 Enterprise Products Partners $33,739 $259 0.8%
 EV Energy Partners (Nasdaq: EVEP  ) $172 $96 55.9%
 Linn Energy, LLC (Nasdaq: LINE  ) $697 $41 5.8%
 ATP Oil & Gas (Nasdaq: ATPG  ) $371 ($632) (170.5%)

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 Enterprise Products Partners 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 51.5% of operating cash flow coming from questionable sources, Enterprise Products Partners investors should take a closer look at the underlying numbers. 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 47.5% of cash flow from operations. Overall, the biggest drag on FCF came from capital expenditures, which consumed 88.7% 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. Enterprise Products Partners LP is a Motley Fool Income Investor choice. 

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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 (5) | Recommend This Article (5)

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 25, 2011, at 10:57 AM, Alorichardlee wrote:

    1) ATPG got deep water drilling permit just now.

    2) Production will be doubled in 3 months from 12000 to 25000 barrels per day.

    3) got upgraded and more upgrades will come soon.

    Can drill and then can produce more revenue, which can blance the balance sheet very soon.

    Predication of year end PPS should be $30 or higher

  • Report this Comment On March 25, 2011, at 11:02 AM, Alorichardlee wrote:

    a) Short term targe is aiming $21-$23 (that was rumor of permit 2 weeks ago).

    Now we got the permit on last Friday (3/18).

    b) Longer term of few months to end of 2011 tartget is $30 and higher.

    Buy buy buy and booya..

  • Report this Comment On March 27, 2011, at 4:05 PM, zorro6204 wrote:

    No, you can't make this kind of analysis from GAAP financials and the cash flow statement, it doesn't work. The metric is DCF, which is funds flow from operations starting from revenues, but including GAAP capital expenses to maintain production, referred to as maintenance capex. GAAP income includes all kinds of transitory nonsense, and OCF from the cash flow statement is also not immune from adjustments that flip back and forth (it also doesn't include maintenance capex).

    For example, 2008-2010, LINE recorded $999,616, $(298,192) and $(114,288) of net income, and OCF of $179,515, $426,804, $270,918, respectively, a complete disconnect from reality as can readily be seen. Did Linn's operations really vary like that? It "lost" money in 2009, but more than doubled operating cash flow off a billion profit year? Huh?? It's GAAP crapola.

    In reality, LINE had a very steady three years, due to aggressive forward hedging, and more than covered its distributions per unit of $2.52, $2.52 and $2.55 per unit with DCF every single quarter.

  • Report this Comment On March 27, 2011, at 4:29 PM, jack3335 wrote:

    Where do you guys find people this ignorant of an industry. You have to throw the entire article out just because the author does not appear to know that EPD is in a completely different business the 3 other companies. EPD is a pipeline,storage,and fractionation company. The others are production companies. EPD is less exposed to energy price fluctuations that the other three which are purely plays on price of energy.

  • Report this Comment On March 28, 2011, at 1:42 PM, zorro6204 wrote:

    Yeah, no kidding, and EPD is about as far as the moon from ATPG, a highly leveraged speculative C corporation. What's that doing in an article about a major MLP? Why not compare it to KMP, etc.? It's just a useless article in all respects.

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Related Tickers

5/31/2016 11:12 AM
EPD $27.95 Up +0.33 +1.19%
Enterprise Product… CAPS Rating: ****
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ATP Oil & Gas Corp CAPS Rating: ***
EVEP $2.59 Up +0.11 +4.44%
EV Energy Partners… CAPS Rating: ***
LINEQ $0.13 Down -0.01 -10.51%
Linn Energy, LLC CAPS Rating: **