What Chevron 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, Chevron (NYS: CVX) .

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

 

2011*

2010

2009

2008

2007

Normalized Net Income$28.5 billion$19.5 billion$10.8 billion$26.1 billion$19.1 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$15.6 billion$11.7 billion($0.5 billion)$10.0 billion$8.3 billion

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

Now we know how much cash Chevron 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 Chevron has returned to shareholders in recent years:

 

2011*

2010

2009

2008

2007

Dividends$6.0 billion$5.7 billion$5.3 billion$5.2 billion$4.8 billion
Share Repurchases$2.6 billion$0.3 billion--$6.8 billion$6.4 billion
Total Returned to Shareholders$8.6 billion$6.0 billion$5.3 billion$12.0 billion$11.2 billion

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

The company has repurchased a decent amount of its own stock. That's caused its shares outstanding to fall over the past five years:

 

2011*

2010

2009

2008

2007

Shares Outstanding (in Millions)1,9931,9971,9922,0382,118

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

anImage

Source: S&P Capital IQ.

Source: S&P Capital IQ.

Sure enough, Chevron repurchased a large amount of stock in 2007, when shares were high, and then ceased entirely in 2009, when they were cheap. Whether this was a prudent use of cash as it looked like the economy was about to implode, or a classic example of a management decision to buy high and panic low, is up for debate. In general, it doesn't appear that Chevron has been the most astute buyer of its own stock.

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

anImage

Source: S&P Capital IQ.

Source: S&P Capital IQ.

Over the past five years, Chevron shares returned 74%, which drops to 48% without dividends -- not a bad boost to top off already 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 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 Chevron's cash? Sound off in the comments section below.

At the time this article was published Fool contributorMorgan Houselowns shares of Chevron. Follow him on Twitter, where he goes by@TMFHousel.Motley Fool newsletter serviceshave recommended buying shares of Chevron. 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 a disclosure policy.

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