What Family Dollar Stores Does With Its Cash

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, Family Dollar Stores (NYSE: FDO).

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

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:

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

Now we know how much cash Family Dollar Stores 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 Family Dollar Stores has returned to shareholders in recent years:

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

As you can see, 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 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 Family Dollar Stores fall into this trap? Let's take a look:

Source: S&P Capital IQ.

Sure enough, Family Dollar Stores bought back a lot of stock in 2007 when shares were fairly high, and none in 2008 as they cratered, only to come roaring back with buybacks after shares rebounded. Whether this was a prudent way to save cash as it looked like the economy was about to implode, or a classic example of buying high and panicking low, is up for debate. In general, it doesn't appear management has been the most astute buyer of its own stock.

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

Source: S&P Capital IQ.

Shares returned 93% over the last five years, which drops to 77% without dividends -- a nice boost to top off already strong 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 Family Dollar Stores' cash? Sound off in the comment section below.

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