Robust Earnings May Not Tell The Whole Story For Verde Agritech (TSE:NPK)

Verde Agritech Plc (TSE:NPK) just reported some strong earnings, and the market rewarded them with a positive share price move. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

View our latest analysis for Verde Agritech

A Closer Look At Verde Agritech's Earnings

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). 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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Verde Agritech has an accrual ratio of 0.40 for the year to March 2022. 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. Over the last year it actually had negative free cash flow of CA$3.5m, in contrast to the aforementioned profit of CA$8.37m. We also note that Verde Agritech's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CA$3.5m.

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 Verde Agritech's Profit Performance

As we discussed above, we think Verde Agritech's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Verde Agritech's underlying earnings power is lower than its statutory profit. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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 while earnings quality is important, it's equally important to consider the risks facing Verde Agritech at this point in time. For example, we've found that Verde Agritech has 2 warning signs (1 makes us a bit uncomfortable!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of Verde Agritech'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. 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. 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.