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, Linear Technology
The first step in analyzing cash flow is to look at net income. Linear Technology's net income over the last five years has been impressive:
|
2011 |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Normalized Net Income | $378 million | $438 million | $193 million | $318 million | $327 million |
Source: S&P Capital IQ.
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 | $549 million | $540 million | $342 million | $468 million | $453 million |
Source: S&P Capital IQ.
Now we know how much cash Linear Technology 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, invested in other companies and assets, or used to pay off debt.
Here's how much Linear Technology has returned to shareholders in recent years:
|
2011 |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Dividends | $223 million | $211 million | $200 million | $190 million | $183 million |
| Share Repurchases | $64 million | $17 million | $12 million | $83 million | $3.1 billion |
| Total Returned to Shareholders | $286 million | $228 million | $211 million | $273 million | $3.3 billion |
Source: S&P Capital IQ.
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) | 232 | 229 | 227 | 224 | 252 |
Source: S&P Capital IQ.
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 Linear Technology fall into this trap? Let's take a look:
Source: S&P Capital IQ.
This doesn't tell us much. Nearly all of Linear Technology's repurchases over the last five years came during one swoop in 2007. Given reasonable valuations at the time, it was likely a decent deal for shareholders.
Finally, I like to look at how dividends have added to total shareholder returns:
Source: S&P Capital IQ.
Shares returned 3% over the last five years, which increases to 20% with dividends reinvested -- a nice boost to top off otherwise low 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 Linear Technology's cash? Sound off in the comment section below.
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