What Cummins 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, Cummins (NYS: CMI) .

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

 

2011

2010

2009

2008

2007

Normalized Net Income$1.6 billion$1.0 billion$459 million$759 million$717 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$1.5 billion$642 million$827 million$444 million$457 million

Source: S&P Capital IQ.

Now we know how much cash Cummins 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 and assets, or to pay off debt.

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

 

2011

2010

2009

2008

2007

Dividends$255 million$172 million$141 million$122 million$89 million
Share Repurchases$629 million$241 million$20 million$128 million$335 million
Total Returned to Shareholders$884 million$413 million$161 million$250 million$424 million

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, if only slightly:

 

2011

2010

2009

2008

2007

Shares Outstanding (millions)193197197195198

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

anImage

Source: S&P Capital IQ.

Cummins ramped up buybacks as shares bounded higher in recent years, but it's pretty clear that this corresponds to a ramp up in cash-flow generation (rather than management exuberance). Given acceptable valuations in relation to growth and cash flow, these buybacks have likely been a decent deal for shareholders.

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

anImage

Source: S&P Capital IQ.

Shares returned 261% over the last five years, which drops to 236% 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 Cummins'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 Cummins. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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

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