What McCormick 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, McCormick (NYS: MKC) .

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

 

2011*

2010

2009

2008

2007

Normalized Net Income$330 million$309 million$294 million$246 million$227 million

Source: S&P Capital IQ. *12 months ended Nov. 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$243 million$275 million$348 million$193 million$244 million

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

Now we know how much cash McCormick 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, used to invest in other companies, or to pay off debt.

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

 

2011*

2010

2009

2008

2007

Dividends$149 million$141 million$129 million$117 million$106 million
Share Repurchases$89 million$133 million‑‑$11 million$146 million
Total Returned to Shareholders$238 million$274 million$129 million$128 million$252 million

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

As you can see, the company has repurchased a decent amount of its own stock. But combined with rounds of share issuance, shares outstanding have actually increased:

 

2011*

2010

2009

2008

2007

Shares Outstanding (millions)133133131130129

Source: S&P Capital IQ. *12 months ended Nov. 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 McCormick fall into this trap? Let's take a look:

anImage

Source: S&P Capital IQ.

Sure enough, McCormick bought back a lot of stock in 2007 when shares were fairly high, and none in 2009 as they cratered, only to come rushing back with buybacks after shares recovered. Whether this was a prudent way to save cash as it looked like the economy was about to implode, or a classic example of buying high and panicking low, is up for debate. In general, it doesn't appear 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.

Shares returned 44% over the last five years, which drops to 27% without dividends -- a nice boost to top off already strong 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 McCormick's cash? Sound off in the comment section below.

At the time this article was published Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Motley Fool newsletter services have recommended buying shares of McCormick. 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.

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