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, Archer Daniels Midland
The first step in analyzing cash flow is to look at net income. Archer Daniels Midland's net income over the last five years has been impressive:
|
2011* |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Normalized Net Income | $2.0 billion | $1.6 billion | $1.1 billion | $2.3 billion | $1.4 billion |
Source: S&P Capital IQ. *12 months ended Sept. 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 | ($0.7 billion) | ($4.1 billion) | ($0.9 billion) | $3.6 billion | ($3.9 billion) |
Source: S&P Capital IQ. *12 months ended Sept. 30.
Now we know how much cash Archer Daniels Midland 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 to pay off debt.
Here's how much Archer Daniels Midland has returned to shareholders in recent years:
|
2011* |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Dividends | $406 million |
$384 million |
$360 million |
$335 million |
$298 million |
| Share Repurchases | $510 million |
$186 million |
-- | $100 million |
$458 million |
| Total Returned to Shareholders | $916 million |
$570 million |
$360 million |
$435 million |
$756 million |
Source: S&P Capital IQ. *12 months ended Sept. 30.
As you can see, the company has repurchased a decent amount of its own stock. But combined with other rounds of share issuance, shares outstanding have actually increased:
|
2011* |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Shares Outstanding (millions) | 650 | 641 | 643 | 644 | 645 |
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 Archer Daniels Midland fall into this trap? Let's take a look:
Source: S&P Capital IQ.
Archer Daniels Midland has only engaged in share repurchases sporadically over the last five years, so it's hard to get a good feel for management's buying activity. Buybacks peaked in 2007 when shares were high, but that's not quite enough information to tell us whether the move was imprudent or not, since buybacks ever since have been minimal -- even after shares rebounded.
Finally, I like to look at how dividends have added to total shareholder returns:
Source: S&P Capital IQ.
Over the last five years, Archer Daniels Midland shares returned 1%, which drops to -9% without dividends -- not a bad boost to top off otherwise poor returns.
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 Archer Daniels Midland's cash? Sound off in the comment section below.
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