What Rockwell Collins 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, Rockwell Collins (NYSE: COL  ) .

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

�	2011	2010	2009	2008	2007
Normalized Net Income	$553 million	$504 million	$529 million	$589 million	$550 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	$372 million	$569 million	$562 million	$436 million	$418 million

Source: S&P Capital IQ.

Now we know how much cash Rockwell Collins 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, invested in other companies and assets, or used to pay off debt.

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

�	2011	2010	2009	2008	2007
Dividends	$146 million	$151 million	$152 million	$141 million	$106 million
Share Repurchases	$572 million	$304 million	$140 million	$393 million	$557 million
Total Returned to Shareholders	$718 million	$455 million	$292 million	$534 million	$663 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)	153	157	158	160	166

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

Source: S&P Capital IQ.

Not that great. Rockwell Collins repurchased a lot of stock in 2007 when shares were fairly high, pulled way back as they plunged in 2009, and came back with buybacks after shares rebounded. No one expects management to time the market perfectly, but the "buy high, ignore the lows" behavior isn't encouraging.

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

Source: S&P Capital IQ.

Shares returned -18% over the last five years, which increases to -10% with dividends reinvested -- a nice boost to top off otherwise low 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 Rockwell Collins' cash? Sound off in the comment section below.

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