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Tickers in this Article: MRK, UPS, DELL, TOL, HPQ
A company's net income and earnings per share can provide insight into its well being and progress over time. That's why these metrics get the headlines. However, there are times when a company's "bottom line" doesn't tell the whole story.

The problem with looking solely at a company's earnings number is that sometimes earnings are hurt one-time events or depreciation, which can muddy the waters. That's where cash flow comes into play. The cash flow statement simply tracks where the company's money goes and may provide a clearer picture of its health. (For related reading, check out Fundamental Analysis: The Cash Flow Statement and The Essentials Of Cash Flow.)

The Basics of Cash Flow
Cash flow statements are no-nonsense. They depict money outflows and inflows and may be a better measure in determining whether the company has the money to cover the important things like its interest payments on a loan or if it has extra money it can spend on a share repurchase program.

Its also important to note that there are times when a company might currently be losing money in terms of its net income, but generating positive cash flow. Under some conditions such a company may be a good investment candidate. If the earnings do turn positive, other investors may start to take notice and the stock could take off. With all of that in mind, here are some companies that have generated operational cash improvements and deserve attention:

Cash Flow Kings

Company Market Cap Operating Cash Flow Growth*
$46.4B $242 Million
Hewlett Packard
$104.3B $3.81 Billion
$78.7B $3.86 Billion
Toll Brothers
$2.97B $467 Million
$59.8B $812 Million
*YTD completed quarter(s) year-over-year increase in dollar terms

Cash Flow Comeback at Merck?
Not so long ago New Jersey-based Merck was widely considered to be the problem child of the pharmaceutical industry largely due to the thousands of Vioxx lawsuits that had been filed against it after the arthritis was pulled from the shelves in late 2004. New life was breathed into the stock's price during 2006 and 2007, I would argue this was largely because it reached a settlement over Vioxx.

Merck didn't get much of a breather. Earlier this year, a study was released that said cholesterol drug Vytorin wasn't any better than the same dose of Zocor, and more recently it received some unfavorable press after a UBS analyst questioned sales of its cervical cancer vaccine, Gardasil.

At the end of the day I still believe Merck has solid upside potential. In the March quarter it reported that net cash provided by operating activities totaled about $2.5 billion. That's a sharp increase over the roughly $1.3 billion in negative operating cash flow it posted in the comparable period last year. According to its last 10-Q filing, Merck has $9.1 billion in cash, equivalents and short-term investments. This cushion provides the flexibility for it to repurchase shares, make an acquisition or simply to hold for a rainy day.

At present, Wall Street expects Merck to earn $3.31 a share this year and $3.64 a share in 2009, which implies an expected growth rate of about 10%. Given that the company trades at just over 11-times the current year's earnings estimate, buying into Merck's growth potential at these prices seems like a reasonable bargain to me.

Bottom Line
There is an old adage: "It takes money to make money." Cash flow is the metric that lets you see how a company spends its cash, and where it is coming from. Sometimes a company looks sicklier than it actually is, and cash flow can help you discern if there is a turnaround opportunity in the works. Not all of the stocks we've looked at are guaranteed to see gains in share price, but having examined their cash flow, it's likely that we could be looking back at them in a year from now and wondering how Wall Street misread the true health of their earning potential.

For related reading, check out Analyze Cash Flow The Easy Way.

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