Many companies talk about how they enhance shareholder value by returning cash through dividends or stock buybacks. But investors shouldn't just take the company's word for it. In this series, we'll investigate how companies have spent free cash flow over the past five years. By doing so, we hope to gain insight into whether the company's management might be good stewards of shareholder capital.

Today, we'll take a look at aerospace and defense company Raytheon (NYSE: RTN).

How does it spend free cash?
First, let's have a look at how much free cash flow the company has generated in each of the past five years and how much has gone toward dividends and buybacks.

 

2010

2009

2008

2007

2006

Buybacks

$1,450

$1,200

$1,700

$1,642

$352

Dividends

$536

$473

$460

$440

$420

Total Paid

$1,986

$1,673

$2,160

$2,082

$772

FCFE

$2,332

$2,277

$1,843

$3,418

$1,661

Source: Capital IQ as of July 27, 2011. Figures in millions.
Free cash flow = net income depreciation-capital expenditures-change in noncash working capital.

Raytheon has been a fairly reliable dividend payer over the past few decades despite holding the payout steady between 1996 and 2004. In the past five years, for example, it has raised its payout at a healthy 12.3% annualized rate.

Buybacks, however, seem to be Raytheon's preferred method of returning shareholder cash -- between 2006 and 2010, Raytheon repurchased over $6 billion of its own shares versus $2.3 billion paid as cash dividends. To its credit, Raytheon's buyback program has been remarkably consistent in recent years.

Is the dividend covered?
Next, let's see how much of the company's free cash flow has gone to dividends.

Metric

2010

2009

2008

2007

2006

FCF Payout Ratio 23% 21% 25% 13% 25%

Source: Capital IQ, a division of Standard & Poor's.

It seems Raytheon can afford its dividend and the current payout is covered nearly five times over by free cash flow. Its 3.7% dividend yield is well-above the S&P 500 average of 2%, which makes it worth a look for dividend-minded investors, but the overhanging concerns are how changes to U.S. defense spending and Raytheon's sizeable pension deficit might affect Raytheon's ability to raise payouts going forward.

Is it a good investor?
Companies are notoriously bad investors in their own stock. Consider that in 2007, when the market was hitting record highs, S&P 500 companies bought back a record $589 billion, versus $246 billion in cash dividends. In 2009, when the market was around its nadir, buybacks hit record lows.

Is Raytheon an exception?

Rtnbuybacksvshareprice

Source: Capital IQ, a division of Standard & Poor's.

Based on this chart, Raytheon appears to have made fairly good use of its buyback spending and it even stepped up its activity in the first quarter of 2009 when many companies were tight-fisted with their cash at precisely the wrong time.  

Competitors
How does Raytheon's use of free cash flow stack up against some of its major competitors over the past four quarters?

Company

Free Cash Flow

Share Buybacks

Dividends

Raytheon $1,873 $1,462 $554
Northrop Grumman (NYSE: NOC) $2,830 $683 $553
Lockheed Martin (NYSE: LMT) $3,209 $2,486 $1,022
General Dynamics (NYSE: GD) $3,251 $1,795 $631

Source: Capital IQ, a division of Standard & Poor's. All figures in millions as based on trailing-12-month data.

Foolish bottom line
In recent years, Raytheon has been a consistent producer of free cash flow and has spent the majority of its free cash on buybacks and dividends. The defense industry is certainly facing a few headwinds, but income-focused investors would be wise to take a closer look at Raytheon.

Todd Wenning is the advisor of Motley Fool (UK) Dividend Edge. You can follow him on Twitter. He doesn't own shares of any company mentioned. The Fool owns shares of Raytheon, Northrop Grumman, General Dynamics, and Lockheed Martin.

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.