In the quest to find great investments, most investors focus on earnings to gauge a company's financial strength. This is a good start, but earnings can be misleading and incomplete. To get a clearer understanding of a company's ability to earn money and reward you, the shareholder, it's often better to focus on cash flow. In this series, we tear apart a company's cash flow statement to see how much money is truly being earned, and more importantly, what management is doing with that cash.

Step on up, Hewlett-Packard (NYSE: HPQ).

The first step in analyzing cash flow is to look at net income. Hewlett-Packard's net income over the last five years has been impressive:

 

2011*

2010

2009

2008

2007

Normalized Net Income $7.2 billion $8.1 billion $6.7 billion $6.7 billion $6.1 billion

Source: S&P Capital IQ. *12 months ended Oct. 30.

Next, we add back in a few non-cash expenses like the depreciation of assets, and adjust net income for changes in inventory, accounts receivable, and accounts payable -- changes in cash levels that reflect a company either paying its bills, or being paid by customers. This yields a figure called cash from operating activities -- the amount of cash a company generates from doing everyday business.

From there, we subtract capital expenditures, or the amount a company spends acquiring or fixing physical assets. This yields one version of a figure called free cash flow, or the true amount of cash a company has left over for its investors after doing business:

 

2011*

2010

2009

2008

2007

Free Cash Flow $8.1 billion $8.3 billion $11.0 billion $9.3 billion $9.9 billion

Source: S&P Capital IQ. *12 months ended Oct. 30.

Now we know how much cash Hewlett-Packard is really pulling in each year. Next question: What is it doing with that cash?

There are two ways a company can use free cash flow to directly reward shareholders: dividends and share repurchases. Cash not returned to shareholders can either be stashed in the bank, used to invest in other companies, or to pay off debt.

Here's how much Hewlett-Packard has returned to shareholders in recent years:

 

2011*

2010

2009

2008

2007

Dividends $834.0
million		 $729.0
million		 $762.0
million		 $783.0
million		 $834.0
million
Share Repurchases $10.1
billion		 $10.6
billion		 $6.6
billion		 $7.5
billion		 $11.9
billion
Total Returned to Shareholders $11.0
billion		 $11.3
billion		 $7.4
billion		 $8.3
billion		 $12.7
billion

Source: S&P Capital IQ. *12 months ended Oct. 30.

As you can see, the company has been a prolific buyer of its own stock. That's caused its shares outstanding to plunge:

 

2011*

2010

2009

2008

2007

Shares Outstanding (millions) 2,094 2,275 2,375 2,446 2,594

Source: S&P Capital IQ. *12 months ended Oct. 30.

Now, companies tend to be fairly poor at repurchasing their own shares, buying feverishly when shares are expensive and backing away when they're cheap. Does Hewlett-Packard fall into this trap? Let's take a look:

Source: S&P Capital IQ.

HP's buybacks have been fairly consistent regardless of share price. There was a slight dip in 2009 when shares fell, but buybacks came back even stronger when shares took another leg down last year. Given how cheap shares current look compared with earnings and cash flow, HP shareholders are getting a good bang for their buck with share repurchases.

Finally, I like to look at how dividends have added to total shareholder returns:

Source: S&P Capital IQ.

Over the last five years, Hewlett-Packard shares returned -33%, which drops to -36% without dividends. HP's dividend is small enough -- and its share decline large enough -- to render it a virtual rounding error.

To gauge how well a company is doing, keep an eye on the cash. How much a company earns is not as important as how much cash is actually coming in the door, and how much cash is coming in the door isn't as important as what management actually does with that cash. Remember, you, the shareholder, own the company. Are you happy with the way management has used Hewlett-Packard's cash? Sound off in the comment section below.