Free cash flow is incredibly popular around here. Why? Because it's the easiest way to gauge how profitable a company is after it has made capital investments. Let's just see what free cash flow can tell us about Pearson's (NYSE: PSO) profitability.

What exactly does Pearson do?
Pearson is a media company that is dominating the education sector right now. Yes, it owns the Financial Times, and yes, it owns Penguin books, but 81% of this company's sales are from providing learning materials, technology, and services to students and teachers in more than 70 countries. Its education revenues are the highest in its peer group.

Show me the money
It's not easy getting to the top, but it's arguably harder staying there. That's where free cash flow comes in. Companies that can increase profitability year after year make it much harder for the competition to take them down. Let's see how Pearson stacks up.


FCF 2010

FCF 2009

FCF 2008

Pearson $1.45 billion $1.22 billion $937 million
McGraw-Hill (NYSE: MHP) $1.34 billion $1.24 billion $1.05 billion
Apollo Group (Nasdaq: APOL) $877 million $833 million $621 million

Source: Yahoo! Finance.

Not bad. Pearson did the best job increasing profitability from year to year, but is there something else to this story?

Free cash flow is great for measuring profitability, but staying on top in an industry necessitates reinvesting. Let's pull apart our free cash flow numbers to get a better look at how much money these companies are putting into capital expenditures.





Pearson $119 million $100 million $109 million
McGraw-Hill $115 million $92 million $131 million
Apollo Group $168 million $127 million $105 million

Source: Yahoo! Finance.

Apollo Group was second to Pearson in education revenue in 2010 and has continued to ramp up capital expenditures. I like Apollo Group's steady growth here. But I also like Pearson's consistent reinvestment. Even when times were tough, it didn't pare back spending in a significant way.

Forward, march
Over the past three years, Pearson has reinvested $328 million in capital expenditures. Its vision for the immediate future includes investing in content, increasing its digital presence, and continuing to expand into rapidly growing emerging markets. Currently, the company operates language schools in China, universities in South Africa, and online tutoring in India, among many other businesses in emerging nations.

The company is quick to point out that the bulk of its education revenue comes from North America, but it also notes that it is increasing its presence in Africa, China, India, Brazil, and the rest of Latin America. Pearson's international-education business has grown at an average annual rate of 18% over the past five years.

Pearson's revenue from international education was $1.9 billion in 2010, compared with Washington Post's (NYSE: WPO) Kaplan International, another major player, which had revenue of $586 million. Kaplan is no slouch; it was fourth in total education revenue in 2010, three spots behind leader Pearson. But you can see how serious the international initiative is at Pearson.

The Foolish takeaway
Free cash flow is an important metric to review, but it doesn't mean a thing if a company doesn't have a plan for forward progress. Analyzing a company's profitability, combined with its reinvestment track record and growth initiatives, is a more complete way to evaluate the potential for future success.

Think Pearson can stay on top? Add it to My Watchlist and find out.