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 important, what management is doing with that cash.

Step on up, Yum! Brands (NYSE: YUM).   

The first step in analyzing cash flow is to look at net income. Yum! Brands' net income over the last five years has been impressive:

 

2011*

2010

2009

2008

2007

Normalized Net Income $1.1 billion $1.1 billion $0.9 billion $0.8 billion $0.7 billion

Source: S&P Capital IQ. *12 months ended Nov. 30.

Next, we add back in a few non-cash 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:

 

2011*

2010

2009

2008

2007

Free Cash Flow $1.3 billion $1.2 billion $0.6 billion $0.6 billion $0.8 billion

Source: S&P Capital IQ. *12 months ended Nov. 30.

Now we know how much cash Yum! Brands 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 be stashed in the bank, used to invest in other companies, or used to pay off debt.

Here's how much Yum! Brands has returned to shareholders in recent years:

 

2011*

2010

2009

2008

2007

Dividends $0.5 billion $0.4 billion $0.4 billion $0.3 billion $0.3 billion
Share Repurchases $0.7 billion $0.4 billion N/A $1.6 billion $1.4 billion
Total Returned to Shareholders $1.2 billion $0.8 billion $0.4 billion $1.9 billion $1.7 billion

Source: S&P Capital IQ. *12 months ended Nov. 30. N/A = not applicable.          

As you can see, the company has repurchased a decent amount of its own stock. That's caused shares outstanding to fall:

 

2011*

2010

2009

2008

2007

Shares Outstanding (Millions) 473 474 471 475 522

Source: S&P Capital IQ. *12 months ended Nov. 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 Yum! Brands fall into this trap? Let's take a look:

Yumbuybacks

Source: S&P Capital IQ.                                                                                                        

There was indeed a brief hiatus in buybacks in 2009 when shares came down a bit in price, but in general, Yum! management looks like it's done a good job when it comes to share repurchases, buying most of its stock over the past five years when shares were below current prices. These repurchases have been a great deal for shareholders.

Finally, I like to look at how dividends have added to total shareholder returns:

Yumreturns

Source: S&P Capital IQ.

Over the last five years, Yum! Brands shares returned 137%, which drops to 113% without dividends -- not a bad boost to top off already outstanding 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 Yum! Brands' cash? Sound off in the comments section below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Yum! Brands. Motley Fool newsletter services have recommended buying shares of Yum! Brands. 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.