What Johnson & Johnson Does With Its Cash

Before you go, we thought you'd like these...
Before you go close icon

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, Johnson & Johnson (NYS: JNJ) .

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

 

2011*

2010

2009

2008

2007

Normalized Net Income

$9.9 billion

$10.0 billion

$10.3 billion

$10.0 billion

$9.7 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:

 

2011*

2010

2009

2008

2007

Free Cash Flow

$11.9 billion

$14.0 billion

$14.2 billion

$11.9 billion

$12.1 billion

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

Now we know how much cash Johnson & Johnson 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 to pay off debt.

Here's how much Johnson & Johnson has returned to shareholders in recent years:

 

2011*

2010

2009

2008

2007

Dividends

$6.1 
billion

$5.8 
billion

$5.3 
billion

$5.0 
billion

$4.7 
billion

Share Repurchases

$3.0 
billion

$2.8 
billion

$2.1 
billion

$6.7 
billion

$5.6 
billion

Total Returned To Shareholders

$9.1 
billion

$8.6 
billion

$7.4 
billion

$11.7 
billion

$10.3 
billion

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

As you can see, the company has repurchased a fair amount of its own stock. That's caused its shares outstanding to fall:

 

2011*

2010

2009

2008

2007

Shares Outstanding (millions)

2,740

2,751

2,760

2,803

2,883

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 Johnson & Johnson fall into this trap? Let's take a look:

anImage

Source: S&P Capital IQ.

Like so many companies, Johnson & Johnson's buybacks dried up 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 Johnson & Johnson'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 last five years, Johnson & Johnson shares returned 14%, which drops to -3% without dividends -- not a bad boost to top off otherwise lowly 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 Johnson & Johnson's cash? Sound off in the comment section below.

At the time this article was published Fool contributor Morgan Housel owns shares of Johnson & Johnson. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of Johnson & Johnson. Motley Fool newsletter services have recommended creating a diagonal call position in Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners