What Ecolab 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, Ecolab (NYSE: ECL  ) .

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

�	2011*	2010	2009	2008	2007
Normalized Net Income	$513 million	$472 million	$437 million	$423 million	$399 million

Source: S&P Capital IQ. *12 months ended Sept. 30.

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	$552 million	$690 million	$443 million	$427 million	$491 million

Source: S&P Capital IQ. *12 months ended Sept. 30.

Now we know how much cash Ecolab 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 either be stashed in the bank, used to invest in other companies, or to pay off debt.

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

�	2011*	2010	2009	2008	2007
Dividends	$158 million	$146 million	$133 million	$129 million	$114 million
Share Repurchases	$126 million	$349 million	$69 million	$337 million	$371 million
Total Returned To Shareholders	$284 million	$495 million	$202 million	$466 million	$485 million

Source: S&P Capital IQ. *12 months ended Sept. 30.

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)	232	233	237	245	247

Source: S&P Capital IQ. *12 months ended Sept. 30.

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

Source: S&P Capital IQ.

This is interesting. Ecolab has been sporadic with its buybacks, but its largest repurchase in the last five years came when shares were at their recessionary lows. That's almost unheard of. There isn't enough information here to get a feel for long-term trends, but it looks like Ecolab management has done a good job with buybacks.

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

Source: S&P Capital IQ.

Over the last five years, Ecolab shares returned 50%, which drops to 40% without dividends -- not a bad boost to top off already high returns.

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 Ecolab's cash? Sound off in the comment section below.

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