A lackluster earnings announcement from DATRON AG (ETR:DAR) last week didn’t sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.
View our latest analysis for DATRON
In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. You could think of the accrual ratio from cashflow as the ‘non-FCF profit ratio’.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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”.
DATRON has an accrual ratio of 0.46 for the year to June 2024. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn’t produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of €16m, in contrast to the aforementioned profit of €3.90m. We also note that DATRON’s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of €16m.
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 have made quite clear, we’re a bit worried that DATRON didn’t back up the last year’s profit with free cashflow. As a result, we think it may well be the case that DATRON’s underlying earnings power is lower than its statutory profit. 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. So if you’d like to dive deeper into this stock, it’s crucial to consider any risks it’s facing. To that end, you should learn about the 2 warning signs we’ve spotted with DATRON (including 1 which can’t be ignored).
Today we’ve zoomed in on a single data point to better understand the nature of DATRON’s profit. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.