What Tim Hortons Does With Its Cash

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, Tim Hortons (NYSE: THI  ) .

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

�	2011	2010	2009	2008	2007
Normalized Net Income	$344 million	$322 million	$320 million	$302 million	$257 million

Source: S&P Capital IQ. *In Canadian dollars.

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	$210 million	$393 million	$282 million	$201 million	$218 million

Source: S&P Capital IQ.

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

�	2011	2010	2009	2008	2007
Dividends	$110 million	$90 million	$73 million	$66 million	$53 million
Share Repurchases	$572 million	$243 million	$130 million	$169 million	$178 million
Total Returned to Shareholders	$683 million	$333 million	$203 million	$235 million	$231 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:

�	2011	2010	2009	2008	2007
Shares Outstanding (millions)	162	174	180	183	188

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

Source: S&P Capital IQ.

It doesn't look terrible, but things could get dicey. Tim Hortons waited until shares boomed to an all-time high before deciding they were cheap enough to buy in big amounts. With shares trading at 22 times earnings, the current buyback binge might very easily end up looking too optimistic down the road.

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

Source: S&P Capital IQ.

Shares returned 73% over the last five years, which increases to 81% with dividends reinvested -- 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 Tim Hortons' cash? Sound off in the comment section below.

• Add Tim Hortons to�My Watchlist.