Solid Earnings Reflect Nextcom's (TLV:NXTM) Strength As A Business

The subdued stock price reaction suggests that Nextcom Ltd.'s (TLV:NXTM) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

See our latest analysis for Nextcom

Zooming In On Nextcom'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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.

Over the twelve months to December 2023, Nextcom recorded an accrual ratio of -0.17. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of ₪44m during the period, dwarfing its reported profit of ₪17.2m. Given that Nextcom had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₪44m would seem to be a step in the right direction. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that Nextcom's profit was boosted by unusual items worth ₪2.8m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. If Nextcom doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Nextcom's Profit Performance

In conclusion, Nextcom's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering all the aforementioned, we'd venture that Nextcom's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Case in point: We've spotted 1 warning sign for Nextcom you should be aware of.

Our examination of Nextcom has focussed on certain factors that can make its earnings look better than they are. 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.