As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company’s underlying profitability. This article will consider whether Silicon Laboratories’ (NASDAQ:SLAB) statutory profits are a good guide to its underlying earnings.
While Silicon Laboratories was able to generate revenue of US$865.1m in the last twelve months, we think its profit result of US$30.3m was more important. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.
Importantly, statutory profits are not always the best tool for understanding a company’s true earnings power, so it’s well worth examining profits in a little more detail. So today we’ll look at what Silicon Laboratories’ cashflow tells us about the quality of its earnings. 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.
Examining Cashflow Against Silicon Laboratories’ Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.
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. 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.
Silicon Laboratories has an accrual ratio of -0.17 for the year to July 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of US$178m during the period, dwarfing its reported profit of US$30.3m. Silicon Laboratories shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Our Take On Silicon Laboratories’ Profit Performance
As we discussed above, Silicon Laboratories’ accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Silicon Laboratories’ statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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. If you want to do dive deeper into Silicon Laboratories, you’d also look into what risks it is currently facing. Case in point: We’ve spotted 1 warning sign for Silicon Laboratories you should be aware of.
Today we’ve zoomed in on a single data point to better understand the nature of Silicon Laboratories’ 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 that insiders are buying.
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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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