What Carpenter Technology 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, Carpenter Technology (NYSE: CRS  ) .

The first step in analyzing cash flow is to look at net income. Carpenter Technology's net income over the last five years has been all over the place:

�	2011	2010	2009	2008	2007
Normalized Net Income	$92 million	$25 million	--	$145 million	$217 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. When a company runs a cash-flow deficit, money is pulled from savings, or raised through debt or equity financing:

�	2011	2010	2009	2008	2007
Free Cash Flow	($22 million)	($51 million)	$139 million	$1 million	$164 million

Source: S&P Capital IQ.

Now we know how much cash Carpenter Technology 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 Carpenter Technology has returned to shareholders in recent years:

�	2011	2010	2009	2008	2007
Dividends	$32 million	$32 million	$32 million	$31 million	$28 million
Share Repurchases	--	--	--	$246 million	$255 million
Total Returned To Shareholders	$32 million	$32 million	$32 million	$277 million	$283 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)	44	44	44	46	51

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 Carpenter Technology fall into this trap? Let's take a look:

Source: S&P Capital IQ.

This is a mixed bag. Carpenter Technology repurchased a lot of stock in 2007 when shares were near their peak -- not good. But it kept buying as shares continued to plunge -- somewhat of a redemption. Combine the two, and management's buyback record over the last five years is decent at best.

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

Source: S&P Capital IQ.

Shares returned -28% over the last five years, which increases to -20% with dividends reinvested -- a nice boost to top off otherwise poor 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 Carpenter Technology's cash? Sound off in the comment section below.

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