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, Medtronic (NYSE: MDT).                                               

The first step in analyzing cash flow is to look at net income. Medtronic's net income over the past five years has been impressive:

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

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

Now we know how much cash Medtronic 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 in the bank, used to invest in other companies, or used to pay off debt.

Here's how much Medtronic has returned to shareholders in recent years:

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

The company has repurchased a decent amount of its own stock. That's caused shares outstanding to fall:

Source: S&P Capital IQ.
*12 months ended Oct. 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 Medtronic fall into this trap? Let's take a look:

Source: S&P Capital IQ. 

This is encouraging. For the most part, Medtronic management has been consistent with share buybacks regardless of share price. Very few companies can say the same thing these days. Given what looks like reasonable valuations in relation to earnings and cash flow, Medtronic's share buybacks have probably been a good deal for shareholders in recent years.

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

Source: S&P Capital IQ.

Over the past five years, Medtronic shares returned -19%, which drops to -27% without dividends -- not a bad boost to top off otherwise poor 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 Medtronic's cash? Sound off in the comments section below.

• Add Medtronic to My Watchlist.