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, J.M. Smucker (NYSE: SJM).

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

 

2011*

2010

2009

2008

2007

Normalized Net Income $533 million $527 million $491 million $221 million $174 million

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

Next, we add back in a few noncash 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 $178 million $461 million $533 million $180 million $175 million

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

Now we know how much cash J.M. Smucker 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 J.M. Smucker has returned to shareholders in recent years:

 

2011*

2010

2009

2008

2007

Dividends $204 million $185 million $162 million $89 million $67 million
Share Repurchases $429 million $247 million $6 million $70 million $86 million
Total Returned to Shareholders $633 million $432 million $168 million $159 million $154 million

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

As you can see, the company has repurchased a decent amount of its own stock. But combined with other rounds of share issuance (mostly to finance acquisitions), shares outstanding have actually increased:

 

2011*

2010

2009

2008

2007

Shares Outstanding (millions) 114 118 118 69 57

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 J.M. Smucker fall into this trap? Let's take a look:

Source: S&P Capital IQ.

Sure enough, J.M. Smucker's big stock purchases over the last five years came only after its shares rebounded from their recession lows. But that doesn't tell us much because acquisitions altered the company's cash flow over the years. Given what look like reasonable valuations in relation to earnings and cash flow, the recent buybacks have likely been a good deal for shareholders.

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

Source: S&P Capital IQ.

Over the last five years, shares returned 78%, which drops to 42% without dividends -- not a bad boost to top off already solid share performance.

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 J.M. Smucker's cash? Sound off in the comment section below.