Where's the Cash Coming From at RF Micro Devices?

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 RF Micro Devices (Nasdaq: RFMD  ) , 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, RF Micro Devices generated $85.6 million cash while it booked a net loss of $27.2 million. That means it turned 10.0% of its revenue into FCF. That sounds OK.

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 RF Micro Devices 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 34.5% of operating cash flow coming from questionable sources, RF Micro Devices investors should take a closer look at the underlying numbers. Within the questionable cash flow figure plotted in the TTM period above, stock-based compensation and related tax benefits provided the biggest boost, at 21.9% of cash flow from operations. Overall, the biggest drag on FCF came from capital expenditures, which consumed 29.1% of cash from operations.

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 has no positions in the stocks mentioned above. 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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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 10:57 AM, taishiba wrote:

    motley fool you articles are GARBAGE!!!!! Horrible clap trap, and propaganda.

    Sounds like you are shorting RFMD big time.

    Big squeeze coming after next earnings.

  • Report this Comment On October 12, 2012, at 3:46 PM, Rokclimber1 wrote:

    $6 or $7 easy by end of 2012 & possibly as high as $10.

    Shorts will lose a bundle while those smart enough will see awesome gains from the mid $3 level.

    Im not saying the author of this is short but certainly could be. Wall Street is known for this. They give TONS of print to help peoples position, normally on the short side, in an effort to help mitigate selling & help the shorter.

    Just look at Kass. Why on earth do they still print his RUBBISH nearly every single day? He is known to short & he rags on companies he is short on every single day & far too many places give him 'print', even tho they are knowingly trying to help him with his short positions but whats worse, look at his track record going back YEARS.

    His track record is awful. If folks followed his advice over the YEARS, they would be broke & penniless, yet after YEARS of AWFUL SHORTING advice which has led to very steep losses to him, his hedge funds & anybody who follows his advice, there he is with 5 articles a day plastered all over.

    Shame on him but more shamefull is 'the press' which keeps printing his rubbish causing many to lose money. & LOTS of it. Can you imagine if you had followed his advice & shorted GOOG at $100, APPLE at $70, AMZN at $28 & the list goes on and on and on......

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