Why the Street Should Love MIPS Technologies' Earnings

Although business headlines still tout earnings numbers, many investors have moved past net earnings as a measurement 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're trying to buy the market's best stocks, it's worth checking up on your companies' free cash flow (FCF) 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 MIPS Technologies (Nasdaq: MIPS  ) , whose recent revenue and earnings are plotted below.

Source: Capital IQ, a division of Standard & Poor's. 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, MIPS Technologies generated $29.7 million cash while it booked net income of $22.9 million. That means it turned 33.8% of its revenue into FCF. That sounds pretty impressive. But since a single-company snapshot doesn't offer much context, it always pays to compare that figure with those of sector and industry peers and competitors, to see how your company stacks up.

Company

TTM Revenue

TTM FCF

TTM FCF Margin

MIPS Technologies $88 $30 33.8%
Intel (Nasdaq: INTC  ) $46,171 $9,624 20.8%
Applied Micro Circuits (Nasdaq: AMCC  ) $248 $21 8.6%
MaxLinear (NYSE: MXL  ) $69 ($2) (3.4%)

Source: Capital IQ, a division of Standard & Poor's. Data is current as of last fully reported fiscal quarter. Dollar values in millions. FCF = free cash flow. TTM = trailing 12 months.

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; it's good to see, but it's ordinary in recessionary times, and you can increase collections only so much. Finally, adding stock-based compensation expenses 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 MIPS Technologies look? Take a peek at the following chart, which flags questionable cash-flow sources with a red bar.

Source: Capital IQ, a division of Standard & Poor's. 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 14.5% of MIPS Technologies' operating cash flow coming from questionable sources, 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 14.5% of cash flow from operations. Overall, the biggest drag on FCF came from capital expenditures, which consumed 3.8% 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. He is a co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. Motley Fool newsletter services have recommended buying shares of and creating a diagonal call position in Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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  • Report this Comment On June 16, 2011, at 12:24 AM, rogerabc100 wrote:

    Excellent article. I agree with most your points and I would like to add my 12 reasons why MIPS earning report will be better than estimate and why MIPS is extremely undervalued:

    1) After the recent meltdown from 18 to $6 and huge accumulation by funds, it will be easy for hedge/mutual funds to push MIPS quickly 50% up. Market cap is tiny $320M and MIPS is the fourth largest microprocessor company after Intel, ARM and AMD

    2)In January 2011 , MIPS unveiled the first MIPS-Based mobile devices, including two smart phones and several tablets. Devices presented by Actions Semiconductor and Ingenic Semiconductor.

    3) MIPS-Based Cruz Tablets can be purchased through major retailers including Amazon, Best Buy, Walmart.com, Borders and many others. See MIPS website

    4) There is a white paper titled ‘Beyond the Hype’ that compares in more detail the specific processor cores from MIPS and ARM, dispelling the myth of ARM’s superior technology. See MIPS website

    5) MIPS claims superiority over ARM cortex in power consumption and smaller size. MIPS processor M14K reduces development time and time-to-market . See MIPS website

    6) MIPS claims that M14K core offers the software developer an instruction set of 300 instructions, twice that available with the ARM's Cortex-M3.

    7) MIPS is well positioned in several rapidly growing Mobile & tablet markets. Compared with ARM processors, MIPS generally offers lower footprint and lower power consumption. This is the reason Chinese government decided to base its supercomputer on MIPS processors.

    8) MIPS is very relevant to the current mobile chip set marketplace, because it has a competitive power consumption advantage, it has 2 years experience in the mobile processors and it is capable of competing with the dominant companies.

    9) The mobile tsunami continues to see very high growth. All major tech savy companies are in a race to get a piece of the mobile pie. MIPS is a prime candidate for a take-over and it only makes sense to acquire this company at less than $1B.

    10) According to NYT article , top 4 takeover parties would be ARM, Intel, RIMM and Google. MIPS was developed by Stanford President John Hennessy and Hennessey currently sits on Google’s Board . Hennessey maybe involved in a major collaboration with Google as MIPS mobile products become competitive. See article in NTY.com

    11) ARM , Intel and AMD was rumored several months ago that is interested in buying MIPS and the rumors makes a lot of business sense because of elimination of competitor. See article in NTY.com

    12) EE Times article says the two mobile processors of ARM and MIPS are dead even in terms of clock frequency. The ARM Cortex-A9MPCore is slightly faster than the MIPS 1074K at the same frequency, but MIPS processor is smaller in silicon area. MIPS lets designer to design their own custom instructions, which ARM doesn’t permit. See article in EEtimes.com

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