NEXT's (LON:NXT) Conservative Accounting Might Explain Soft Earnings

The market was pleased with the recent earnings report from NEXT plc (LON:NXT), despite the profit numbers being soft. We think that investors might be looking at some positive factors beyond the earnings numbers.

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Examining Cashflow Against NEXT'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. 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.

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

NEXT has an accrual ratio of -0.10 for the year to January 2025. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of UK£976m in the last year, which was a lot more than its statutory profit of UK£736.1m. NEXT shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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 NEXT's Profit Performance

As we discussed above, NEXT has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that NEXT's statutory profit actually understates its earnings potential! And the EPS is up 16% annually, over the last three years. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example - NEXT has 1 warning sign we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of NEXT'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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.