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, Computer Sciences (NYSE: CSC).
The first step in analyzing cash flow is to look at net income. Computer Sciences' net income over the last five years has been all over the place:
|
2011 |
2010 |
2009 |
2008 |
2007 | |
|---|---|---|---|---|---|
| Normalized Net Income | ($583 million) | $602 million | $680 million | $617 million | $655 million |
Source: S&P Capital IQ.
Next, we add back in a few noncash 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 | $857 million | $1.4 billion | $886 million | $983 million | $760 million |
Source: S&P Capital IQ.
Now we know how much cash Computer Sciences 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 and assets, or to pay off debt.
Here's how much Computer Sciences has returned to shareholders in recent years:
|
2011 |
2010 |
2009 |
2008 |
2007 | |
|---|---|---|---|---|---|
| Dividends | $124 million | $46 million | -- | -- | -- |
| Share Repurchases | $65 million | $1 million | $2 million | $542 million | $475 million |
| Total Returned to Shareholders | $189 million | $47 million | $2 million | $542 million | $475 million |
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) | 155 | 154 | 152 | 153 | 171 |
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 Computer Sciences fall into this trap? Let's take a look:
Source: S&P Capital IQ.
Not great. Most of Computer Sciences' buybacks over the last five years occurred well above current prices. Given reasonable valuations, these buybacks were likely a decent deal for shareholders, but management's buybacks record is hardly remarkable.
Finally, I like to look at how dividends have added to total shareholder returns:
Source: S&P Capital IQ.
Shares returned -50% over the last five years, which increases to -48% with dividends reinvested -- a small boost to top off otherwise poor 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 Computer Sciences' cash? Sound off in the comment section below.
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