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, Clorox
The first step in analyzing cash flow is to look at net income. Clorox's net income over the last five years has been impressive:
| Year |
2011* |
2010 |
2009 |
2008 |
2007 |
|---|---|---|---|---|---|
| Normalized net income |
$499 million |
$577 million |
$537 million |
$477 million |
$488 million |
Source: S&P Capital IQ. *12 months ended Sept. 30.
Next, we add back in a few noncash 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:
| Year |
2011* |
2010 |
2009 |
2008 |
2007 |
|---|---|---|---|---|---|
| Free cash flow |
$450 million |
$582 million |
$604 million |
$427 million |
$615 million |
Source: S&P Capital IQ. *12 months ended Sept. 30.
Now we know how much cash Clorox 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 either be stashed away in the bank, used to invest in other companies, or to pay off debt.
Here's how much Clorox has returned to shareholders in recent years:
| Year |
2011* |
2010 |
2009 |
2008 |
2007 |
|---|---|---|---|---|---|
| Dividends |
$305 million |
$295 million |
$270 million |
$240 million |
$211 million |
| Share repurchases |
$660 million |
$284 million |
-- |
-- |
$934 million |
| Total returned to shareholders |
$970 million |
$580 million |
$270 million |
$240 million |
$1.1 billion |
Source: S&P Capital IQ. *12 months ended Sept. 30.
As you can see, the company has repurchased quite a bit of its own stock. That's caused its shares outstanding to fall:
| Year |
2011* |
2010 |
2009 |
2008 |
2007 |
|---|---|---|---|---|---|
| Shares outstanding (millions) | 135 | 140 | 140 | 138 | 146 |
Source: S&P Capital IQ. *12 months ended Sept. 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 Clorox fall into this trap? Let's take a look:
Source: S&P Capital IQ.
The majority of Clorox's buybacks over the last five years came in one big repurchase in late 2007. That happened to be a time when Clorox stock (and the economy) were temporarily peaking, but shares weren't dramatically overvalued at the time. In general, management has done a fair job with share repurchases.
Finally, I like to look at how dividends have added to total shareholder returns:
Source: S&P Capital IQ.
Over the last five years, Clorox shares have returned 24%, which drops to 7% without dividends -- not a bad boost to top off otherwise low share 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 Clorox's cash? Sound off in the comments section below.
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