Even though Constellation Software Inc.’s (TSE:CSU) recent earnings release was robust, the market didn’t seem to notice. Our analysis suggests that investors might be missing some promising details.
See our latest analysis for Constellation Software
As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company’s free cash flow (FCF) matches its profit. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company’s profit is not backed by free cashflow.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it’s worth noting where the accrual ratio is rather high. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Over the twelve months to June 2024, Constellation Software recorded an accrual ratio of -0.32. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of US$2.0b during the period, dwarfing its reported profit of US$649.0m. Constellation Software’s free cash flow improved over the last year, which is generally good to see.
That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.
As we discussed above, Constellation Software’s accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Constellation Software’s underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. At the end of the day, it’s essential to consider more than just the factors above, if you want to understand the company properly. In light of this, if you’d like to do more analysis on the company, it’s vital to be informed of the risks involved. You’d be interested to know, that we found 2 warning signs for Constellation Software and you’ll want to know about these.
This note has only looked at a single factor that sheds light on the nature of Constellation Software’s profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to ‘follow the money’ and search out stocks that insiders are buying. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.