What Cardinal Health 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, Cardinal Health (NYS: CAH) .

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

 

2011*

2010

2009

2008

2007

Normalized Net Income$1.0 billion$0.9 billion$0.8 billion$1.0 billion$1.3 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$1.4 billion$1.3 billion$1.8 billion$1.0 billion$0.6 billion

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

Now we know how much cash Cardinal Health 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 be stashed in the bank, invested in other companies, or used to pay off debt.

Here's how much Cardinal Health has returned to shareholders in recent years:

 

2011*

2010

2009

2008

2007

Dividends$0.3 billion$0.3 billion$0.2 billion$0.2 billion$0.2 billion
Share Repurchases$0.3 billion$0.5 billion$0.1 billion$0.1 billion$3.9 billion
Total Returned to Shareholders$0.6 billion$0.8 billion$0.3 billion$0.3 billion$4.1 billion

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

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

 

2011*

2010

2009

2008

2007

Shares Outstanding (millions)348353359356374

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

anImage

Source: S&P Capital IQ.

Sure enough, Cardinal Health bought back a lot of stock in 2007 when shares were high, and almost none in 2009 after they crashed. Part of this was due to spinoffs and reorganizations that altered the company's cash flow, but in general it doesn't look like management 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.

Over the last five years, shares returned -13%, which drops to -43% without dividends -- a nice boost to top off otherwise poor 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 Cardinal Health's cash? Sound off in the comment section below.

Add Cardinal Health to My Watchlist.

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 @TMFHousel.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.

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