Why Telefonaktiebolaget LM Ericsson's (STO:ERIC B) Earnings Are Better Than They Seem

The stock was sluggish on the back of Telefonaktiebolaget LM Ericsson (publ)'s (STO:ERIC B) recent earnings report. We have done some analysis, and found some encouraging factors that we believe the shareholders should consider.

See our latest analysis for Telefonaktiebolaget LM Ericsson

Examining Cashflow Against Telefonaktiebolaget LM Ericsson's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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 2024, Telefonaktiebolaget LM Ericsson recorded an accrual ratio of -0.49. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of kr43b, well over the kr20.0m it reported in profit. Telefonaktiebolaget LM Ericsson's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

The Impact Of Unusual Items On Profit

Telefonaktiebolaget LM Ericsson's profit was reduced by unusual items worth kr20b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. In the twelve months to December 2024, Telefonaktiebolaget LM Ericsson had a big unusual items expense. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

Our Take On Telefonaktiebolaget LM Ericsson's Profit Performance

Considering both Telefonaktiebolaget LM Ericsson's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon Telefonaktiebolaget LM Ericsson's statutory profit probably understates its earnings potential! So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 2 warning signs for Telefonaktiebolaget LM Ericsson you should know about.

After our examination into the nature of Telefonaktiebolaget LM Ericsson's profit, we've come away optimistic for the company. 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 with high insider ownership.

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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.