Melexis' (EBR:MELE) Solid Earnings May Rest On Weak Foundations

Melexis NV's (EBR:MELE) healthy profit numbers didn't contain any surprises for investors. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

See our latest analysis for Melexis

Zooming In On Melexis' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Melexis has an accrual ratio of 0.21 for the year to June 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. To wit, it produced free cash flow of €70m during the period, falling well short of its reported profit of €208.7m. Given that Melexis had negative free cash flow in the prior corresponding period, the trailing twelve month resul of €70m would seem to be a step in the right direction.

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.

Our Take On Melexis' Profit Performance

Melexis' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Melexis' statutory profits are better than its underlying earnings power. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To that end, you should learn about the 2 warning signs we've spotted with Melexis (including 1 which doesn't sit too well with us).

Today we've zoomed in on a single data point to better understand the nature of Melexis' profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.