What Coca-Cola Does With Its Cash

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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 importantly, what management is doing with that cash.

Step on up, Coca-Cola (NYS: KO) .

The first step in analyzing cash flow is to look at net income. Coke's net income over the past five years has been impressive:

Year

2011*

2010

2009

2008

2007

Normalized Net Income

$6.6 billion

$6 billion

$5.8 billion

$4.9 billion

$4.8 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:

Year

2011*

2010

2009

2008

2007

Free Cash Flow  

$6.3 billion

$7.3 billion

$6.2 billion

$5.6 billion

$5.5 billion

Source: S&P Capital IQ.
*12 months ended Sept. 30.

Now we know how much cash Coca-Cola 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 either be stashed in the bank, used to invest in other companies, or used to pay off debt.

Here's how much Coca-Cola has returned to shareholders in recent years:

Year

2011*

2010

2009

2008

2007

Dividends

$3.2 billion

$4.1 billion

$3.8 billion

$3.5 billion

$3.1 billion

Share Repurchases

$6.6 billion

$3 billion

$1.5 billion

$1.1 billion

$1.8 billion

Total Returned to Shareholders

$9.8 billion

$7.1 billion

$5.3 billion

$4.6 billion

$4.9 billion

Source: S&P Capital IQ.
*12 months ended Sept. 30. Appearance of falling dividend caused by calendar quirk. Coke has not cut its total dividend payout.

The company has repurchased a fair amount of its own stock. That's caused its shares outstanding to fall:

Year

2011*

2010

2009

2008

2007

Shares Outstanding (Millions)

2,295

2,308

2,314

2,315

2,313

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 Coca-Cola fall into this trap? Let's take a look:

anImage

Source: S&P Capital IQ.

Like so many companies, Coke's buybacks dried up almost entirely in 2009, when its stock was dirt-cheap. Whether this was a prudent move to save cash while the economy looked like it was about to go over a cliff, or a missed opportunity, is up for debate. Since Coke's stock has looked reasonably valued in recent years, I think management has broadly done a fair job with share repurchases.

Finally, I like to look at how dividends have added to total shareholder returns:

anImage

Source: S&P Capital IQ.

Over the past five years, Coca-Cola shares returned 60%, which drops to 38% without dividends -- not a bad boost to top off otherwise 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 Coke's cash? Sound off in the comments section below.

At the time this article was published Fool contributorMorgan Houseldoesn't own shares in any of the companies mentioned in this article. Follow him on Twitter, where he goes by@TMFHousel.The Motley Fool owns, andMotley Fool newsletter services have recommended buying, shares of Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.

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