Robust Earnings May Not Tell The Whole Story For Nepa (STO:NEPA)

The market shrugged off Nepa AB (publ)'s (STO:NEPA) solid earnings report. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

View our latest analysis for Nepa

Examining Cashflow Against Nepa'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Nepa has an accrual ratio of 1.20 for the year to September 2022. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of kr32.8m, a look at free cash flow indicates it actually burnt through kr6.4m in the last year. It's worth noting that Nepa generated positive FCF of kr23m a year ago, so at least they've done it in the past.

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 Nepa's Profit Performance

As we have made quite clear, we're a bit worried that Nepa didn't back up the last year's profit with free cashflow. For this reason, we think that Nepa's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that its earnings per share increased slightly in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 3 warning signs for Nepa (of which 1 is a bit concerning!) you should know about.

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

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.