Big cash flow no guarantee of company’s financial health

The Motley Fool The Motley FoolMarch 3, 2013 

Might a company that rakes in a lot of money still be a bad investment? – L.D., Worcester, Mass.

It’s possible. Remember that the money a company takes in (its revenue, or sales) is its top line. Before you get to its bottom line of profits, you have to take out expenses, such as salaries, supplies and taxes. It’s critical to know how much (if anything) the company keeps as profit, and whether important numbers, such as sales and profits, are increasing.

Arch Coal, for example, has had average annual revenue growth of more than 12 percent during the past five years, and growth has accelerated. But its earnings have been uneven and recently entered negative territory.

That’s worrisome, but ailing companies can be good investments sometimes – if they turn themselves around. Study their financial reports, see if they’re gaining or losing market share, how strong their competitive advantages are, how much faith you have in their management and whether their futures seem promising.

Look for red flags such as major legal problems or investigations into accounting. Or just skip them and focus instead on profitable firms.

FOOLISH TRIVIA

I trace my roots back to 1862 (yes, during the Civil War) and railway legislation signed by Abraham Lincoln. Based in Omaha, I’m a top American transportation enterprise, with a railroad network spanning 23 states (mainly in the West) and more than 30,000 miles. I employ more than 40,000 people, use more than 8,000 locomotives and rake in more than $20 billion annually as I serve about 10,000 customers. My biggest customers include steamship lines, vehicle manufacturers, agricultural companies, utilities, intermodal companies and chemical manufacturers. My tag lines include “Building America” and “You’ll Find Us.” Who am I?

Last Week’s Trivia Answer: I was founded in 1929 as a moth-proofing business in Chicago. Today, based in Memphis, I’m a worldwide network of roughly 7,000 residential and commercial service businesses – company-owned, franchised and licensed. Who am I? Answer: ServiceMaster

THE MOTLEY FOOL TAKE

With shares of Apple (Nasdaq: AAPL) down about 15 percent in 2013 and more than 30 percent below their all-time high in September, many investors are wondering whether it’s best to get in or get out of the stock.

There’s a lot to like about the company. It has more than $100 billion in cash and cash equivalents, and sports a dividend recently yielding 2.3 percent. Better still, all those billions represent potential. With them, the company can boost its dividend, buy back lots of shares or otherwise invest in the company, such as by buying smaller firms. (Of course, much of its cash is abroad, and bringing it stateside will trigger taxation.)

Also appealing are net profit margins above 20 percent, and the stock’s seemingly low valuation, with a recent price-to-earnings ratio of about 11 and analysts expecting annual growth of 19 percent during the coming five years.

Look before you leap, though. That projected growth rate is far lower than Apple’s growth rate in recent years. Apple has been incredibly innovative, introducing new categories of products, but it may not be able to keep doing so. And it has recently dropped prices on some of its offerings, which will shrink its profit margins.

Fool’s School

Preparing your own tax return can be a challenge, owing to the complexity of the tax code. It makes sense to hire a pro to do it, as she might be able to save you some big bucks by helping you take advantage of available credits or deductions.

Choose a pro carefully, though, perhaps beginning by seeking referrals. Then ask for an interview. The accountant should be willing to discuss and assess your situation for free before you strike any agreement.

Ask questions such as these:

 • How big is your firm? (How important will your business be to the company?)

 • What are your fees and billing policies? (Ask for an estimate.)

 • Who exactly will be preparing my taxes – you or someone else? Whom do I approach with questions?

 • What are your continuing professional education requirements, and how many hours do you normally take each year? (Someone exceeding the requirements is a good sign.)

 • What research material do you use and subscribe to? (Answers such as “CCH,” “Research Institute” and “BNA” are encouraging. If the answer is merely the current Federal Tax Handbook, that’s a red flag. Some of us have complicated tax issues that require deep research. You don’t want your tax geek just giving it his best shot. Being correct is always best when dealing with the IRS.)

 • If my return is audited, will you represent me before the IRS? (Ideally, he should go instead of you, not with you. If the accountant sources out the audit work, think twice before signing up. If he insists that you also be present at an audit, think a third time.)

 • When will you be able to complete the work?

Also, select someone with whom you’re comfortable. Someone might be the best tax technician, but if you aren’t comfortable with him, you might not provide all the information he needs to do a good job for you. Learn more at fool.com/taxes.

Reach the Gardners at fool@fool.com, or Motley Fool, 1130 Walnut, Kansas City, MO 64106.

The News Tribune is pleased to provide this opportunity to share information, experiences and observations about what's in the news. Some of the comments may be reprinted elsewhere in the site or in the newspaper. We encourage lively, open debate on the issues of the day, and ask that you refrain from profanity, hate speech, personal comments and remarks that are off point. Thank you for taking the time to offer your thoughts.

Commenting FAQs | Terms of Service