How much cash do the companies in your portfolio have in their coffers?
It's a pertinent question these days, as credit concerns have helped topple companies left and right. But companies with cash coming in don't need to worry about how they'll pay the bills.
So here's what you need to look for, if you want to find stocks with solid cash flows.
The Statement of Cash Flows
The statement of cash flows is one of three big financial statements that companies release to their investors. The other two: the income statement and the balance sheet.
The statement of cash flows breaks down the cash a company gets (or spends) as a result of their operating (normal business), financing, or investing activities (for more, check out "
If you always thought that the amount of cash a company gets isn't much different from its income, think again. Income gets recorded when services are rendered or products are delivered -- not necessarily when cash trades hands.
And while that may sound like a technicality, it's really not. Lots of companies see a long time pass between delivering their product and collecting the cash for it.
Just think about the last time you saw a commercial for furniture stores that let you defer payment for 90 days when you buy a
from them. If you buy a new sofa this month with those terms, the store will record the sale in 2008, but since you won't have to pay up until January 2009, cash and income won't equal each other.
The difference between cash and income is more significant now than ever.
Companies who can't meet their obligations with cash on hand are having trouble borrowing money from loss-weary
. Companies with positive cash flows have a significant cushion of
compared to those who don't.
Cashing In With Free Cash Flow
One of the most important metrics you'll find on the statement of cash flows is free cash flow (FCF). Free cash flow tells investors how much incoming cash a company has to grow their business and distribute to shareholders.
FCF is calculated by taking "Operating Cash Flows" (from the statement of cash flows) and subtracting "Capital Expenditures" (or "capex"):
Operating Cash Flows - Capital Expenditures = Free Cash Flow
as an example.
If you look at Exxon's statement of cash flows, you'll see that cash from operating activities for 2007 was $52 billion and capital expenditures were $15.4 billion. So then, Exxon's 2007 free cash flow was an impressive $36.6 billion. This huge amount represents essentially cold hard cash that they could do with as they pleased.
Exxon's not the only company that's been recording big FCF numbers. Just check out
. These are a few other companies that hold top spots for generating free cash flow in the last 12 months.
But size isn't everything when it comes to the value of a company's free cash flow.
As with the
, looking at trends over time is a much more relevant way to use FCF to judge a company's prospects. Just look back to Exxon Mobil, whose free cash flow increased 28% between 2005 and 2008. As an investor, that tells me that this company is capable of growing its cash position if it has to (and a quick glance at its balance sheet confirms it has, adding $10 billion in cash to its balance sheet over the last year).
At smaller companies, you won't see FCF numbers the size of Exxon Mobil's, but you should be looking for healthy cash flow trends like theirs.
What About Negative Cash Flows?
Negative cash flow probably doesn't have the best connotation, especially in an age when consumers are constantly scolded for their spend-more-than-you-have mentality. Even so, it's important to remember that negative cash flows don't necessarily have to be a bad thing.
Not sure about that?
In the past year, there were 1,196 stocks that had negative cash flows, but still made gains.
When you run across a company with negative cash flows, your first question should be, "Why?"
Cyclical industries (like retail and the automakers) are one place where negative cash flows in their slow quarters are probably just business as usual. Likewise, don't expect positive cash flow numbers right out of the gate for young companies who are still working on growing their business.
As with companies with stronger cash flow numbers, positive changes over time are an important thing to look for if your investment has negative cash flows.
And remember, if your company has enough cash on their books to weather the current economic storm, and a justifiable excuse for their lack of greenbacks, negative cash flows might be forgivable in the short term.
Lessons in Liquidity
If the stock market has shown us anything in the last several months, it's been that liquidity is a valuable thing to have right now. That's why it's essential to look at the most liquid of all assets -- cash -- if you're thinking about plunking any money down in this market.
It's easy to forget about the statement of cash flows. After all, it's probably the least talked about of the financial statements. But good investors know that cash flows can mean the difference between a successful quarter and getting crunched by creditors.
Jonas Elmerraji is the founder and publisher of Growfolio.com, an online business magazine for young investors.