As an individual investor, analyzing a company's financial statements is sometimes no easy task. There are many companies out there that have relatively simple business operations and straight-forward financial reporting practices. However, there are also many that have convoluted accounting practices that can leave the individual investor scratching their head when it comes to assessing otherwise basic items such as earnings per share.
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Murky Earnings, Clear Cash Flow
In fact reported earnings are a great example of where the number on the income statement may often not tell the whole story about a company's performance. One-time events and negative charges that are not expected to impact ongoing business operations can undo an entire year's profit. Or intangible assets such as goodwill can be written off to substantially lower values, making what could have been decent quarterly earnings results look like a disaster.
It's time like these where the individual investor can gain insight by looking at the cash flow statement. This financial statement tracks the physical flows of money, aggregating them into a single number representing the total amount of cash that came in to (or out of) a company during the reporting period. (For related reading, check out Fundamental Analysis: The Cash Flow Statement.)
The Basics of Cash Flow
While net earnings numbers can at times be skewed far away from the real earnings performance of a company, cash flow typically represents the true state of a company's operations. In that regard, cash flow is often a better measure than earnings when determining how profitable a company is, and whether or not it is generating enough cash to service the interest payments on its outstanding debt.
Here are five stocks that have generated substantial amounts of operating cash flow over the recent year, and therefore may be good candidates for follow-up research:
|Company||Market Cap||Operating Cash Flow (TTM)|
|Safeway (NYSE:SWY)||$7.6 B||$2.46 B|
|Macy\'s (NYSE:M)||$7.4 B||$1.6 B|
|The Travelers Companies (NYSE:TRV)||$24.5 B||$4.0 B|
|AT&T (NYSE:T)||$142.6 B||$33.8 B|
|Ford Motor Co. (NYSE:F)||$35.7 B||$14.7|
|Data as of Market Close July 7, 2010|
Safeway Revenues Still Safe?
A perfect example of this type of divergence between accounting earnings and actual operating cash flow is found in Safeway's most recently filed annual financial statements. Taking a look at the company's top-line sales revenue, the company did experience some difficulty in its most recently completed fiscal year (ending January 2, 2010).
Safeway managed to haul in $40.9 billion in sales, which represents a 7.3% decline from its previous year's sales tally of $44.1 billion. Given the tough economic climate of that past year, it is understandable to experience a moderate decline in sales, as cost-conscious consumers preferred to shop at low-cost discount supermarkets instead of at Safeway's more middle-of-the-road outlets.
Earnings Looking Downright Dismal
However, when an investor turns their attention to the bottom line earnings reported by the company for its completed 2009 fiscal year, the results appear downright terrible, at least, on the surface. Safeway reported a net loss of $1.1 billion for 2009, which stands in stark contrast to the $965 million in profit earned in 2008, and the $888 million the year before that.
So what happened? Without looking any further at the company's financial statements, an individual pressed for time and succumbing to their emotions might well be scared away from this stock entirely. But reviewing the income statement in more detail, while top-line sales did suffer year-over-year, the bulk of the ghastly bottom-line earnings performance is in fact due to a non-recurring charge of almost $2 billion that was booked in 2009, due to the effects of the recession and Safeway's decreased market capitalization.
Cash Flow Tells the Truth
While doing the above analysis is useful (and not particularly difficult once you get comfortable reading financial statements), a short cut is to go directly to Safeway's cash flow statement and review the operating cash flow numbers reported there. Indeed, Safeway reported operating cash flow of $2.5 billion in 2009, up from $2.3 billion the year prior and $2.2 billion the year before that.
While the 2009 non-recurring charge is not the only factor at play, these numbers reveal the general truth that Safeway's actual operating performance has been more or less stable these past three years, and not indicative of a dramatic worsening of bottom-line performance in 2009.
The Bottom Line
There are times when a company's reported income can deviate significantly from the physical cash flow performance it is able to achieve. Cutting through the accounting noise often included in financial statements is crucial for an individual investor to determine an accurate picture of a given company's health, and just may allow you to uncover the occasional overlooked bargain from time to time as well.
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