What Sherwin-Williams Does With Its Cash

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, Sherwin-Williams (NYSE: SHW  ) .

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

 

2011*

2010

2009

2008

2007

Normalized Net Income $445 million $424 million $417 million $490 million $577 million

Source: S&P Capital IQ. *12 months ended Sept. 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 $529 million $581 million $768 million $759 million $709 million

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

Now we know how much cash Sherwin-Williams 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 Sherwin-Williams has returned to shareholders in recent years:

 

2011*

2010

2009

2008

2007

Dividends $154 million $156 million $163 million $165 million $162 million
Share Repurchases $451 million $376 million $530 million $393 million $863 million
Total Returned to Shareholders $605 million $532 million $693 million $558 million $1.0 billion

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

As you can see, the company has repurchased a decent amount of its own stock. That's caused shares outstanding to fall:

 

2011*

2010

2009

2008

2007

Shares Outstanding (millions) 104 107 114 117 127

Source: S&P Capital IQ. *12 months ended Sept. 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 Sherwin-Williams fall into this trap? Let's take a look:

Source: S&P Capital IQ.

This is encouraging. While there is quarter-to-quarter volatility, Sherwin-Williams' buybacks are fairly consistent regardless of share price. Very few companies can say the same these days. Given what looks like reasonable valuations in relation to earnings and cash flow, these 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 58%, which drops to 41% 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 Sherwin-Williams' cash? Sound off in the comment section below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Motley Fool newsletter services have recommended buying shares of Sherwin-Williams. 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.


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