What MasterCard 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, MasterCard (NYS: MA) .                                                                                                           

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

 

2011*

2010

2009

2008

2007

Normalized Net Income$2.1 billion$1.8 billion$1.5 billion$1.3 billion$1.0 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 -- fluctuations 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, the true amount of cash a company has left over for its investors after doing business:

 

2011*

2010

2009

2008

2007

Free Cash Flow$2.5 billion$1.6 billion$1.3 billion$0.3 billion$0.7 billion

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

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

 

2011*

2010

2009

2008

2007

Dividends$78 million$79 million$79 million$79 million$74 million
Share Repurchases$1.1 billion----$0.6 billion$0.6 billion
Total Returned To Shareholders$1.2 billion$79 million$79 million$0.7 billion$0.7 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)129131130130135

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

anImage

Source: S&P Capital IQ.

This doesn't tell us much. MasterCard has been sporadic with buybacks, and its share price has essentially only gone one way in the last five years: up. Based on growth and valuation, what buybacks the company has engaged in have likely been a good deal for shareholders.

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

anImage

Source: S&P Capital IQ.

Shares have returned 301% over the last five years, which drops to 296% without dividends -- a small boost to top off already-great performance. MasterCard's dividends aren't enough to make a big difference to returns.                                                               

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 MasterCard's cash? Sound off in the comment 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 @TMFHousel.The Motley Fool owns shares of MasterCard. 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 adisclosure policy.

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

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