DATRON's (ETR:DAR) Profits Appear To Have Quality Issues

Following the solid earnings report from DATRON AG (ETR:DAR), the market responded by bidding up the stock price. Despite this, our analysis suggests that there are some factors weakening the foundations of those good profit numbers.

See our latest analysis for DATRON

Zooming In On DATRON's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

DATRON has an accrual ratio of 0.47 for the year to December 2023. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of €4.48m, a look at free cash flow indicates it actually burnt through €12m in the last year. 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 €12m.

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 DATRON's Profit Performance

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. 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. Case in point: We've spotted 2 warning signs for DATRON you should be mindful of and 1 of these is significant.

This note has only looked at a single factor that sheds light on the nature of DATRON's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 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.