Although headlines still spray earnings figures all over the media every day, many investors have moved past net earnings as a measure of a company's economic output. That's because an earnings statement is very often less trustworthy than a cash flow statement; it's more open to manipulation based on dubious judgment calls.
The unreliability of the income statement is one of the reasons Foolish investors often flip straight to the cash flow statement instead. In general, by taking a close look at the cash moving in and out of the business, you can get a better look at whether or not the last batch of earnings brought money into the company, or merely disguised a cash gusher with a pretty headline.
Calling all cash flows
It's worth checking up on your companies' free cash flow (FCF) once a quarter or so, to see whether it bears any relationship to the net income in the headlines. That brings us to Google
That means Google turned 34% of its revenue into FCF -- an amazing feat at first glance. But it always pays to compare that figure to the numbers posted by a company's sector and industry peers, to see how your company stacks up against its competitors.
|
Company |
LTM Revenue* |
TTM FCF* |
TTM FCF Margin |
|---|---|---|---|
|
Akamai Technologies |
$889 |
$515 |
58% |
|
Adobe Systems |
$3,257 |
$1,170 |
36% |
|
AOL |
$3,058 |
$889 |
29% |
|
Apple |
$51,123 |
$14,846 |
29% |
|
Acxiom |
$1,099 |
$297 |
27% |
*Numbers in millions.
Among its competitors and peers, Akamai Technologies comes in with the highest FCF margin (defined as FCF/trailing-12-month revenue), with 58% of its revenue turning into FCF.
All cash is not equal
Unfortunately, the cash flow statement isn't immune from nonsense, either. That's why it pays to take a close look at the components of free cash flow from operations, to ensure that these sources of cash are of good quality. We want sources that are real and replicable in the upcoming quarters, and not offset by continual cash outflows that don't appear on the income statement (such as major capital expenditures).
For instance, cash flow based on cash net income and predictable depreciation? That's generally good stuff. An increase in cash flow based on stiffing your suppliers (by increasing accounts payable) or stiffing Uncle Sam on taxes? Those will come back to bite investors later. The same goes for decreasing accounts receivable -- it's good to see, but it's ordinary in recessionary times, and you can only increase collections so much.
So, how does the cash flow at Google look? Take a peek at the chart below, which flags questionable cash flow sources with a red bar.
Cash flow statement line items such as changes in taxes payable, tax benefits from stock options, and asset sales, among other items, look questionable to me. I'm not saying that the companies booking these items as sources of cash flow are weak, or are engaging in any sort of wrongdoing. But whenever a company is getting more than, say, 10% of its cash from operations from these dubious sources, I feel obliged to crack open the filings and dig even deeper, if only to make sure that I'm in touch with the true cash profitability.
With questionable cash sources comprising 8% of the cash flow from operations at Google, I'm not too worried. Still, I would be a good idea to keep an eye on this in the future.
A Foolish final thought
If you take the time to read past the headlines and crack a filing now and then, you're probably ahead of 95% of your individual-investor peers. By keeping an eye on the health of your companies' cash flow, you can spot potential trouble early, or figure out whether the numbers merit Mr. Market's pessimism.
Let us know what you think of the health of Google's cash flows in the comments box below. Or, if you're itching to learn more, head on over to our quotes page to view the filings directly.
