What Limited Brands Does With Its Cash

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Editor's note: An earlier version of this article did not account for Limited Brands' special dividend in December 2011. We regret the error.

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, Limited Brands (NAS: LTD) .

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

 

2011

2010

2009

2008

2007

Normalized Net Income$684 million$728 million$401 million$361 million$551 million

Source: S&P Capital IQ.

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$882 million$1.0 billion$972 million$475 million$16 million

Source: S&P Capital IQ.

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

 

2011

2010

2009

2008

2007

Dividends$1.1 billion$1.5 billion$193 million$201 million$227 million
Share Repurchases$1.1 billion$207 million--$379 million$1.4 billion
Total Returned to Shareholders$2.2 billion$1.7 billion$193 million$580 million$1.6 billion

Source: S&P Capital IQ.

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)310323322335375

Source: S&P Capital IQ.

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

anImage

Source: S&P Capital IQ.

Sure enough, Limited Brands repurchased a lot of stock in 2007 and 2008 when shares were fairly high-priced, and none when they came crumbling down, only to come roaring back with buybacks after shares surged. 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 155% over the last five years, which drops to 77% without dividends -- a nice boost to top off already high 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 Limited Brands' 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. 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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