For the individual investor taking an active role in managing their own portfolio, analyzing corporate earnings statements can sometimes pose quite a challenge. The reason for this is, while the structures of income statements are generally consistent from one company to the next, the significance of the numbers that appear within each often varies widely from one to the other.
IN PICTURES: Obtaining Credit In A Bad Economy
No Two Earnings Are Alike
In fact, two particular companies with identical annual net incomes almost certainly brought in different amounts of actual cash during the year. This is because any number of non-recurring events or non-cash charges can weigh on a company's reported income. While these negative items reduce lower the accounting earnings a company reports, they do not have affect the actual amount of cash a company generates in a given year.
In fact, by lowering reported earnings, non-cash charges can actually improve a company's cash flow, since lower income taxes are paid on a reduced income amount.
On the flip side, reported earnings can be significantly greater than the actual amount of cash a company receives. This is because items such as accounts receivable can be the source of a large portion of a company's sales, and while reported the same as cash sales for accounting purposes, credit sales obviously can't pay for cash expenses, such as interest due on outstanding debt. Cash flow can also be greater than reported income due to other regularly occurring items, such as depreciation of long-term assets or changes in inventory levels from one period to the next.
Cash Flow Clears the Way
Beyond these few simple examples, there are numerous situations in which a company's actual cash flow can differ significantly from its reported earnings. As such, individual investors should also review the cash flow statement, in order to get a more accurate perception of a company's ability to generate the cash necessary to pay its bills. (For related reading, check out Fundamental Analysis: The Cash Flow Statement and The Essentials Of Cash Flow.)
Beyond only establishing that a given company is generating sufficient amounts of cash flow, searching for companies that are also trading a relative low share price in comparison to their cash flow per share is a good way to find undervalued bargains. At the very least, stocks with high cash flow yields are less likely to see drastic share price declines in the future, provided their cash flow remains intact.
With that in mind, here are five stocks that have generated substantial amounts of operating cash flow over the recent year, yet remain reasonably priced on a forward earnings basis, and therefore may be good candidates for follow-up research:
|Company||Market Cap||Operating Cash Flow (TTM)||Forward P/E|
|Pfizer (NYSE: PFE)||$131.6 B||$7.1 B||6.7|
|Raytheon (NYSE: RTN)||$17.6 B||$2.5 B||8.7|
|PPL Corporation (NYSE: PPL)||$10.5 B||$2.3 B||9.0|
|Unitedhealth Group (NYSE: UNH)||$36.8 B||$6.0 B||8.7|
|Whirlpool Corp. (NYSE: WHR)||$6.4 B||$1.7 B||8.8|
|Data as of Market Open Aug 03, 2010|
Raytheon's Earnings in Disguise
Raytheon provides a clear example of this type of situation. For its 2009 fiscal year, the company reported a net income of $1.9 billion. While this represented a substantial decrease from its performance two years ago when it earned a total of $2.6 billion, its cash flow statement tells a different story.
The company had over $400 million each in non-cash charges for depreciation and other adjustments to net income, which when added back to the reported income and combined with other items aggregates to an operating cash flow total of $2.7 billion. This is substantially higher than its 2007 operating cash flow of $1.2 billion, as in that year reported earnings were significantly boosted by non-cash changes in liabilities, inventories and other adjustments to net income.
The Bottom Line
While reported earnings are definitely and important piece of the puzzle, they often don't tell the whole story, requiring investors to look beyond the income statement and analyze a company's cash flow in order to get a complete perception of its operating performance.
Raytheon provides a good example of a quality business that may be overlooked by a superficial review of its income statement or an earnings-based stock screen, as its true operating performance as revealed by its cash flow statement is significantly better than its recent year's net income would otherwise indicate. (To learn more, see The Essentials Of Cash Flow.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
Stock AnalysisJ.C. Penney is without a doubt turning itself around, but that doesn't guarantee the stock will respond immediately.
Stock AnalysisA summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
Options & FuturesInvesting during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
Investing BasicsHeld onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
EconomicsWill remaining calm and staying long present significant risks to your investment health?
Stock AnalysisIs DKS a bargain here?
Investing NewsA third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
Stock AnalysisHome Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
Stock AnalysisYelp investors have had reason to be happy recently. Will the good spirits last?
Stock AnalysisWalmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
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 >>
A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
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 >>
The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>