Why Humana's (STO:HUM) Shaky Earnings Are Just The Beginning Of Its Problems

Following the release of a lackluster earnings report from Humana AB (publ) (STO:HUM) the stock price made a strong positive move. Our analysis suggests that there are some positive factors lying below the troubling profit numbers which investors are finding comfort in.

See our latest analysis for Humana

Zooming In On Humana'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). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. 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.

For the year to September 2024, Humana had an accrual ratio of -0.13. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of kr739m during the period, dwarfing its reported profit of kr124.0m. Humana's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

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.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Humana issued 8.4% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Humana's EPS by clicking here.

How Is Dilution Impacting Humana's Earnings Per Share (EPS)?

Humana's net profit dropped by 58% per year over the last three years. And even focusing only on the last twelve months, we see profit is down 46%. Sadly, earnings per share fell further, down a full 47% in that time. And so, you can see quite clearly that dilution is influencing shareholder earnings.

If Humana's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

The Impact Of Unusual Items On Profit

Surprisingly, given Humana's accrual ratio implied strong cash conversion, its paper profit was actually boosted by kr76m in unusual items. 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. And, after all, that's exactly what the accounting terminology implies. If Humana 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 Humana's Profit Performance

Summing up, Humana's accrual ratio suggests that its statutory earnings are well matched by cash flow while its unusual items boosted the profit in a way that might not be repeated. Meanwhile, the dilution was a negative for shareholders. Based on these factors, we think that Humana's statutory profits probably make it seem better than it is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Humana at this point in time. For instance, we've identified 4 warning signs for Humana (1 makes us a bit uncomfortable) you should be familiar with.

Our examination of Humana has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.