In recent articles, the topic of cash flow has been prevalent. It was firstly important to understand exactly what cash flow means and also how to interpret cash flow in light of major mergers and acquisitions.
It is also vitally important to examine how a company utilizes its cash flow in order to benefit the business and the shareholder.
- The first thing that we should look at when we examine a company’s cash flow is to determine if the cash flow is rising or falling. Obviously, we would prefer to have rising cash flow.
- Secondly, the company’s cash flow must cover its capital expenditures as well as dividend payments. When these two items are covered, the company is less likely to take on excessive debt.
- Third, and perhaps most important, is that the company must make good business decisions will excess cash flow. Some companies have squandered millions of dollars on poor acquisitions when they could have raised the dividend or implemented a stock buyback plan.
All in all, we should identify companies that generate excess cash flow and use it to reward the investor.
As an example, 3M is such a company:
- You can set your watch by their yearly dividend increase
- They buy back tons of shares (19 million shares in 2005)
- The number of shares outstanding has fallen more than 14% since the early 1990’s