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, Valspar
The first step in analyzing cash flow is to look at net income. Valspar's net income over the last five years has been impressive:
|
2011* |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Normalized Net Income | $220 million | $214 million | $179 million | $154 million | $164 million |
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 | $225 million | $170 million | $327 million | $160 million | $167 million |
Source: S&P Capital IQ. *12 months ended Oct. 30.
Now we know how much cash Valspar 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 be stashed in the bank, invested in other companies, or used to pay off debt.
Here's how much Valspar has returned to shareholders in recent years:
|
2011* |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Dividends | $68 million | $65 million | $61 million | $57 million | $53 million |
| Share Repurchases | $253 million | $206 million | $82 million | $23 million | $89 million |
| Total Returned to Shareholders | $321 million | $271 million | $143 million | $80 million | $142 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. That's caused shares outstanding to fall:
|
2011* |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Shares Outstanding (millions) | 94 | 98 | 100 | 100 | 101 |
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 Valspar fall into this trap? Let's take a look:
Source: S&P Capital IQ.
This doesn't tell us much, but what's there is not encouraging. Valspar didn't have any appetite to buy its stock at $20 per share, but couldn't get enough near $40 a share. Whether this was a prudent way to save cash as it looked like the economy was about to implode or a classic example of buying high after panicking low is up for debate. In general, it doesn't appear management has been the most astute buyer of its own stock.
Finally, I like to look at how dividends have added to total shareholder returns:
Source: S&P Capital IQ.
Shares returned 84% over the last five years, which drops to 64% without dividends -- a nice boost to top off already strong 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 Valspar's cash? Sound off in the comment section below.
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