Why Buffalo Wild Wings's Earnings May Not Be So Hot

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 once a quarter or so, to see whether it bears any relationship to the net income in the headlines. That's what we do with this series. Today, we're checking in on Buffalo Wild Wings (Nasdaq: BWLD  ) , whose recent revenue and earnings are plotted below.

Source: S&P Capital IQ. 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, Buffalo Wild Wings generated $25.3 million cash while it booked net income of $54.8 million. That means it turned 2.8% of its revenue into FCF. That doesn't sound so great. FCF is less than net income. Ideally, we'd like to see the opposite.

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 flows are of high quality. What does that mean? To me, it means 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 for the short term) 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. Finally, adding stock-based compensation expense back to cash flows is questionable when a company hands out a lot of equity to employees and uses cash in later periods to buy back those shares.

So how does the cash flow at Buffalo Wild Wings look? Take a peek at the chart below, which flags questionable cash flow sources with a red bar.

Source: S&P Capital IQ. 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 11.2% of operating cash flow coming from questionable sources, Buffalo Wild Wings 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 6.5% of cash flow from operations. Overall, the biggest drag on FCF came from capital expenditures, which consumed 82.5% of cash from operations. Buffalo Wild Wings investors may also want to keep an eye on accounts receivable, because the TTM change is 2.6 times greater than the average swing over the past 5 fiscal years.

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. The Motley Fool owns shares of Buffalo Wild Wings. Motley Fool newsletter services recommend Buffalo Wild Wings. 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.


Read/Post Comments (2) | Recommend This Article (1)

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 October 12, 2012, at 8:34 AM, Eohippus617 wrote:

    This is where Motley Fool has its weakest talents. They run this cash flow stuff on dozen of stocks each quarter and try to fit every square, oblong, triangle company into to ther round peg of numbers without any specificity as to why the particularly stock may not have the numbers that make sense for that particular analysis. In this case of course they are spending 82,% of FCF on Capital expenditures because they are adding 100 new restaturants a year. That is what growth stocks do.

    They cover their asses by saying do your own due diligence- mostly because they haven't done any of their own. What's worse is they know better, since they routinely tout this stock because of its fast growth. I would much rather they did this for 10 sotcks then a 100 and acutally do some due diligence rather than cookie cutter all of the stocks through their various number machinations without diligence on why the particular stock may not fit their one dimensional analysis.

    The worst part of all is then they put a title on this guaranteed to be controversial and in this case very wrong so they can drum up more business and readers but not tied to reality- As long as it fits the cookie cutter and they get more members.. Not impressive Mr. Fool.

  • Report this Comment On October 16, 2012, at 12:47 PM, SPARTANBURG wrote:

    "Over the past 12 months, Buffalo Wild Wings generated $25.3 million cash while it booked net income of $54.8 million. That means it turned 2.8% of its revenue into FCF. That doesn't sound so great. FCF is less than net income"

    I can understand how you derived the figure $25.8 million in cash (the $54.8 mil is straight forward). I used numbers from Quarterly Stats in Caps. I also can't understand how you get the 2.6% number.

    Appreciate a reply

    thomas

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