We Like The Quality Of Spectra Systems' (LON:SPSY) Earnings

Spectra Systems Corporation (LON:SPSY) announced a healthy earnings result recently, and the market rewarded it with a strong stock price reaction. According to our analysis of the report, the strong headline profit numbers are supported by strong earnings fundamentals.

Check out our latest analysis for Spectra Systems

Examining Cashflow Against Spectra Systems' 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'.

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

Spectra Systems has an accrual ratio of -0.19 for the year to December 2021. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of US$7.5m, well over the US$5.16m it reported in profit. Spectra Systems 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 Spectra Systems' Profit Performance

Happily for shareholders, Spectra Systems produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Spectra Systems' statutory profit actually understates its earnings potential! And the EPS is up 28% annually, 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. At Simply Wall St, we found 2 warning signs for Spectra Systems and we think they deserve your attention.

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