Investors appear disappointed with Neurogene Inc.’s (NASDAQ:NGNE) recent earnings, despite the decent statutory profit number. We think that they may be worried about something else, so we did some analysis and found that investors have noticed some soft numbers underlying the profit.
Check out our latest analysis for Neurogene
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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company’s average operating assets over that period. You could think of the accrual ratio from cashflow as the ‘non-FCF profit ratio’.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While it’s not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, “firms with higher accruals tend to be less profitable in the future”.
Over the twelve months to June 2024, Neurogene recorded an accrual ratio of 7.96. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of US$2.36m, a look at free cash flow indicates it actually burnt through US$67m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of US$67m, this year, indicates high risk. However, that’s not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. The good news for shareholders is that Neurogene’s accrual ratio was much better last year, so this year’s poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.
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.
The fact that the company had unusual items boosting profit by US$16m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can’t deny that higher profits generally leave us optimistic, but we’d prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that’s exactly what the accounting terminology implies. Assuming those unusual items don’t show up again in the current year, we’d thus expect profit to be weaker next year (in the absence of business growth, that is).
Neurogene had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we’d argue Neurogene’s profits probably give an overly generous impression of its sustainable level of profitability. So if you’d like to dive deeper into this stock, it’s crucial to consider any risks it’s facing. Every company has risks, and we’ve spotted 4 warning signs for Neurogene (of which 3 are significant!) you should know about.
In this article we’ve looked at a number of factors that can impair the utility of profit numbers, and we’ve come away cautious. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.