Why XPO Logistics's Earnings May Not Be So Hot

Although business headlines still tout earnings numbers, many investors have moved past net earnings as a measure of a company's economic output. That's because earnings are very often less trustworthy than cash flow, since earnings are more open to manipulation based on dubious judgment calls.

Earnings' unreliability is one of the reasons Foolish investors often flip straight past the income statement to check the cash flow statement. In general, by taking a close look at the cash moving in and out of the business, you can better understand whether the last batch of earnings brought money into the company, or merely disguised a cash gusher with a pretty headline.

Calling all cash flows
When you are trying to buy the market's best stocks, it's worth checking up on your companies' free cash flow once a quarter or so, to see whether it bears any relationship to the net income in the headlines. That's what we do with this series. Today, we're checking in on XPO Logistics (NYS: XPO) , whose recent revenue and earnings are plotted below.


Source: S&P Capital IQ. Data is current as of last fully reported fiscal quarter. Dollar values in millions. FCF = free cash flow. FY = fiscal year. TTM = trailing 12 months.

Over the past 12 months, XPO Logistics burned $17.9 million cash while it booked a net loss of $12.5 million. That means it burned through all its revenue and more. That doesn't sound so great. FCF is less than net income. Ideally, we'd like to see the opposite.

All cash is not equal
Unfortunately, the cash flow statement isn't immune from nonsense, either. That's why it pays to take a close look at the components of cash flow from operations, to make sure that the cash flows are of high quality. What does that mean? To me, it means they need to be real and replicable in the upcoming quarters, rather than being offset by continual cash outflows that don't appear on the income statement (such as major capital expenditures).

For instance, cash flow based on cash net income and adjustments for non-cash income-statement expenses (like depreciation) is generally favorable. An increase in cash flow based on stiffing your suppliers (by increasing accounts payable for the short term) or shortchanging Uncle Sam on taxes will come back to bite investors later. The same goes for decreasing accounts receivable; this is good to see, but it's ordinary in recessionary times, and you can only increase collections so much. Finally, adding stock-based compensation expense back to cash flows is questionable when a company hands out a lot of equity to employees and uses cash in later periods to buy back those shares.

So how does the cash flow at XPO Logistics look? Take a peek at the chart below, which flags questionable cash flow sources with a red bar.

Source: S&P Capital IQ. Data is current as of last fully reported fiscal quarter. Dollar values in millions. TTM = trailing 12 months.

When I say "questionable cash flow sources," I mean items such as changes in taxes payable, tax benefits from stock options, and asset sales, among others. That's not to say that companies booking these as sources of cash flow are weak, or are engaging in any sort of wrongdoing, or that everything that comes up questionable in my graph is automatically bad news. But whenever a company is getting more than, say, 10% of its cash from operations from these dubious sources, investors ought to make sure to refer to the filings and dig in.

With 38.8% of operating cash flow coming from questionable sources, XPO Logistics investors should take a closer look at the underlying numbers. Within the questionable cash flow figure plotted in the TTM period above, stock-based compensation and related tax benefits provided the biggest boost. Overall, the biggest drag on FCF came from changes in accounts receivable, which represented 32.4% of cash from operations.

A Foolish final thought
Most investors don't keep tabs on their companies' cash flow. I think that's a mistake. If you take the time to read past the headlines and crack a filing now and then, you're in a much better position to spot potential trouble early. Better yet, you'll improve your odds of finding the underappreciated home-run stocks that provide the market's best returns.

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The article Why XPO Logistics's Earnings May Not Be So Hot originally appeared on Fool.com.

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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rmoos81529

Trying to leave a comment not sure you got it. But here goes again. I looked at your chart but I am not able to completly understand it. i am not a stock anylist or a account but I am a guy who spent 50 years in the trucking business and 17 years running a 5 million dollar a year brokerage biz that I started from nothing. The number that I allways looked at is what I billed my customers and what I payed the carriers. I believed you call that gross profit. I see that xpr claims there\'s is abourt 15 percent. Not bad. Many things trouble me about this co. When I look at the directors and management team I only see one person with trucking experience and no one with any brokerage experience. Most with big degrees is various. The other thing is all the hipe over nothing. Example they opened an office is Jax. and have 15 employees what does that have to do with anything. They expect to have 50 to 100 employees within 5 years. Explain to me what a 100 employees would be doing in a office that has no operations attached to it. All operations are handled in CTE. They also located the office close to the univ. so they could hire college grads. One of the most ridicous things I have ever herd. If they think they can hire young college grads. and train them and they will produce any meanfull freight within six months they are dead wrong. Most sales people in the biz cant produce enough freight to cover there salaries. There are only a handful of people who have freight and most of them have jobs they are happy at. I would like to hear your thought on what I have written. Ron email rmoos81529@aol.com

January 18 2013 at 4:33 PM Report abuse +1 rate up rate down Reply