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 important, what management is doing with that cash.
Step on up, IBM
The first step in analyzing cash flow is to look at net income. IBM's net income over the last five years has been impressive:
|
2011* |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Normalized Net Income | $13.1 billion | $12.3 billion | $11.6 billion | $10.5 billion | $9 billion |
Source: S&P Capital IQ. *12 months ended Sept. 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:
|
2011* |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Free Cash Flow | $15.3 billion | $15.4 billion | $17.3 billion | $14.6 billion | $11.5 billion |
Source: S&P Capital IQ. *12 months ended Sept. 30.
Now we know how much cash IBM 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 away in the bank, used to invest in other companies, or used to pay off debt.
Here's how much IBM has returned to shareholders in recent years:
|
2011* |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Dividends | $3.4 billion | $3.2 billion | $2.9 billion | $2.6 billion | $2.1 billion |
| Share Repurchases | $15.1 billion | $15.4 billion | $7.4 billion | $10.6 billion | $18.8 billion |
| Total Returned to Shareholders | $18.5 billion | $18.6 billion | $10.3 billion | $13.2 billion | $20.9 billion |
Source: S&P Capital IQ. *12 months ended Sept. 30.
As you can see, the company has been a prolific buyer of its own shares. That's caused its shares outstanding to fall:
|
2011* |
2010 |
2009 |
2008 |
2007 |
|
|---|---|---|---|---|---|
| Shares Outstanding (Millions) | 1,214 | 1,269 | 1,327 | 1,369 | 1,434 |
Source: S&P Capital IQ. *12 months ended Sept. 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 IBM fall into this trap? Let's take a look:
Source: S&P Capital IQ.
On an annualized basis, IBM has been a fairly steady purchaser of its own stock, save for a pullback in 2009 when it looked like the economy was going to fall off a cliff (and IBM's stock happened to be dirt cheap). Shares haven't looked particularly expensive in recent years in relation to earnings, so in general I think IBM management has been a fairly good purchaser of its own stock. In 2010, value investor Bill Miller noted: "IBM is the only one of the megacap stocks that were popular in the late 1990s to go to an all-time high. The reason for that is, IBM has an absolutely unequal record in capital allocation."
Finally, I like to look at how dividends have added to total shareholder returns:
Source: S&P Capital IQ.
Over the last five years, IBM shares have returned about 97%, which drops to 81% without dividends -- not a bad boost to top off already decent share 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 IBM's cash? Sound off in the comments section below.
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