dormakaba Holding's (VTX:DOKA) Conservative Accounting Might Explain Soft Earnings

dormakaba Holding AG's (VTX:DOKA) recent soft profit numbers didn't appear to worry shareholders, as the stock price showed strength. However, we think the company is showing some signs that things are more promising than they seem.

Check out our latest analysis for dormakaba Holding

Examining Cashflow Against dormakaba Holding's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to June 2024, dormakaba Holding recorded an accrual ratio of -0.17. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of CHF188m during the period, dwarfing its reported profit of CHF42.2m. dormakaba Holding did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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 Impact Of Unusual Items On Profit

dormakaba Holding's profit was reduced by unusual items worth CHF53m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect dormakaba Holding to produce a higher profit next year, all else being equal.

Our Take On dormakaba Holding's Profit Performance

In conclusion, both dormakaba Holding's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think dormakaba Holding's earnings potential is at least as good as it seems, and maybe even better! If you'd like to know more about dormakaba Holding as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 2 warning signs for dormakaba Holding you should be aware of.

After our examination into the nature of dormakaba Holding's profit, we've come away optimistic for the company. 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.