The unreliability of the income statement is one of the reasons Foolish investors often flip straight past it and the balance sheet to eyeball the cash flow statement. In general, by taking a close look at the cash moving in and out of the business, you can get a better look at whether or not the last batch of earnings brought money into the company, or merely disguised a cash gusher with a pretty headline.
Calling all cash flows
It's worth checking up on your companies' free cash flow (FCF) once a quarter or so, to see if it bears any relationship to the net income in the headlines. That's what brings us to Akamai Technologies (Nasdaq: AKAM), which has produced $328 million in FCF over the trailing 12 months, compared to $150 million in net income.
That means that Akamai Technologies turned 37% of its revenues into FCF. That looks amazing. But it always pays to compare that figure to sector and industry peers and competitors to see how your company stacks up.
TTM FCF Margin
VeriSign (Nasdaq: VRSN)
Compuware (Nasdaq: CPWR)
Symantec (Nasdaq: SYMC)
McAfee (NYSE: MFE)
NetApp (Nasdaq: NTAP)
Among its competitors and peers, VeriSign comes in with the highest FCF margin (defined as FCF / trailing-12-months revenue), with 37% of its revenues turning into FCF. But Akamai is ahead of the entire pack. Of course, these businesses are dissimilar in many ways, so it’s not surprising that Compuware, Symantc, and McAfee have different cash margin levels. But is cash flow really that healthy at Akamai?
All cash is not equal
Unfortunately, the cash flow statement isn't immune from nonsense either. That's why it pays to take a close look at the components of free cash flow from operations, to make sure that these sources of cash are of good quality: In other words, that they're real, and replicable, in the upcoming quarters and not offset by continual cash outflows that don't appear on the income statement (such as major capital expenditures). For instance, cash flow based on cash net income and predictable depreciation? Generally good stuff. An increase in cash flow based on stiffing your suppliers (by increasing accounts payable) or stiffing Uncle Sam on taxes? Those will come back to bite investors. The same goes for decreasing accounts receivable. This is good to see, but it's ordinary in recessionary times, and you can only increase collections so much.
So, how does the cash flow at Akamai Technologies look? Take a peek at the chart below, which flags questionable cash flow sources with a red bar.
I characterize as questionable cash flow statement line items such as changes in taxes payable, tax benefits from stock options, asset sales, and other items. That's not to say that companies booking these as sources of cash flow are weak or are engaging in any sort of wrongdoing. But whenever a company is getting more than, say, 10% of its cash from operations from these questionable sources, I feel obliged to crack open the filings and dig even deeper to make sure I am in touch with the true cash profitability.
With questionable cash sources comprising 34% of the cash flow from operations for Akamai Technologies, I think it's time to do a little more digging. Much of the questionable cash flow at Akamai comes from adjustment for stock compensation expenses, as these are technically “non-cash.” However, since Akamai has been spending big bucks buying back shares, stockholders might want to adjust their expectations accordingly. Most of the rest of the questionable cash comes from deferred taxes, another unreliable source.
Foolish final thought
If you are the kind of investor who takes the time to read past the headlines and crack a filing now and then, you're probably ahead of 95% of the rest of the individual investors out there. By keeping an eye on the health of your companies' cash flow, you can spot potential trouble early or figure out if Mr. Market's pessimism is warranted by the numbers. Let us know what you think of the health of the cash flows at Akamai Technologies in the comments box below. Or, if you're itching to learn more, head on over to our quotes page to view the filings directly.
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