On the surface, Dell's (Nasdaq: DELL) third-quarter results were not all inspiring of the future economic recovery that we have come to see from other blue-chip type companies. Total revenue was down 15% compared to a year ago, and net income was down a whopping 54 percent.

IN PICTURES: 20 Tools For Building Up Your Portfolio

It's Not All About Profits
Without question, net income matters to a business over the long term. Often, however, investors can become fixated on the short-term profitability of a company. Such a limited view can often lead to focusing on the trees instead of the forest. In Dell's case, the company is in the midst of completing several strategic initiatives geared to reducing operating expenses. One can see signs of these initiatives working by analyzing the cash flow statement. (For further reading, check out The Essentials Of Cash Flow.)

Count The Cash
One of my favorite investors today is Bruce Berkowitz, who oversees the Fairholme Funds. One of his key investing parameters is focusing on companies where he can count the cash easily. In other words, Fairholme is more concerned with free cash flow (FCF) than net income. That's why Fairholme Funds holds big positions in names like Pfizer (NYSE: PFE), Coca-Cola (NYSE: KO) and Forest Labs (NYSE: FRX).

In a similar fashion, observing Dell's cash flow numbers helps provide a more complete picture. Dell generated $800 million in operating cash flow (OCF) in the quarter compared to an $86 million use of cash from operations one year ago. For the first nine months of the year, OCF was $2.6 billion compared to $1.2 billion in 2008. FCF, as measured by deducting capital expenditures from OCF, was approximately $400 million in the Q3 and $1.5 billion for the nine months of 2009. That compares with no FCF in the comparable 2008 period. (For related reading, check out Analyze Cash Flow The Easy Way.)

Headed In The Right Direction
Looked at in this way, Dell is clearly headed in the right direction. The company's market cap is $28 billion, but once you take out a net cash position of $9 billion, the EV is $19 billion. In 2007 and 2008, Dell produced more than $3 billion in free cash flow. In 2008 the number was $1.5 billion, the same amount Dell has produced so far this year. So while Dell shares currently fetch about 17 times earnings, the company is trading for about nine times EV/FCF based on an estimated $2 billion to $2.2 billion in FCF for the year. That's an attractive multiple for a company of this quality.

Compare that with Apple (Nasdaq: AAPL), which currently commands an EV of $157 billion, which earned $9 billion in FCF in 2008 and approximately $6.3 billion so far in 2009, suggesting an EV/FCF multiple of 15. Microsoft (Nasdaq: MSFT), with an EV of $236 billion, produced about $16 billion in FCF last year, or a ratio of 15 as well.

Bottom Line
Cash matters a lot, and Dell produces tons of it. Successful execution of its strategic initiatives should lead to more cash generation and a much more valuable enterprise. (For more, see Spotting Cash Cows.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  2. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  3. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
  4. Investing News

    Who Does Cheap Oil Benefit? See This Stock (DG)

    Cheap oil won't benefit most companies, but this retailer might buck that trend.
  5. Investing

    How to Ballast a Portfolio with Bonds

    If January and early February performance is any guide, there’s a new normal in financial markets today: Heightened volatility.
  6. Stock Analysis

    Performance Review: Emerging Markets Equities in 2015

    Find out why emerging markets struggled in 2015 and why a half-decade long trend of poor returns is proving optimistic growth investors wrong.
  7. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  8. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  9. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  10. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center