Ferretti's (HKG:9638) Earnings Are Weaker Than They Seem

Ferretti S.p.A.'s (HKG:9638) robust earnings report didn't manage to move the market for its stock. We did some digging, and we found some concerning factors in the details.

Check out our latest analysis for Ferretti

Examining Cashflow Against Ferretti'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. 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. 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.

Ferretti has an accrual ratio of 0.30 for the year to December 2023. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of €59m, in contrast to the aforementioned profit of €83.0m. We saw that FCF was €64m a year ago though, so Ferretti has at least been able to generate positive FCF in the past. One positive for Ferretti shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Our data indicates that Ferretti insiders have been buying shares! You can click here to find out who, and how much.

Our Take On Ferretti's Profit Performance

Ferretti's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Ferretti's true underlying earnings power is actually less than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example - Ferretti 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 Ferretti'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. 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 that insiders are buying to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.