Investors Shouldn't Be Too Comfortable With NextVision Stabilized Systems' (TLV:NXSN) Earnings

Despite posting some strong earnings, the market for NextVision Stabilized Systems, Ltd.'s (TLV:NXSN) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.

See our latest analysis for NextVision Stabilized Systems

Zooming In On NextVision Stabilized 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. 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.

For the year to December 2023, NextVision Stabilized Systems had an accrual ratio of 1.03. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. Indeed, in the last twelve months it reported free cash flow of US$20m, which is significantly less than its profit of US$27.6m. We note, however, that NextVision Stabilized Systems grew its free cash flow over the last year. The good news for shareholders is that NextVision Stabilized Systems' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of NextVision Stabilized Systems.

Our Take On NextVision Stabilized Systems' Profit Performance

As we have made quite clear, we're a bit worried that NextVision Stabilized Systems didn't back up the last year's profit with free cashflow. For this reason, we think that NextVision Stabilized Systems' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing NextVision Stabilized Systems at this point in time. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of NextVision Stabilized Systems.

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

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.