Powell Industries' (NASDAQ:POWL) Earnings Are Of Questionable Quality

Investors were disappointed with Powell Industries, Inc.'s (NASDAQ:POWL) earnings, despite the strong profit numbers. We did some digging and found some worrying underlying problems.

Our free stock report includes 1 warning sign investors should be aware of before investing in Powell Industries. Read for free now.

Zooming In On Powell Industries' 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. 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'.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Powell Industries has an accrual ratio of 1.35 for the year to March 2025. 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$51m, which is significantly less than its profit of US$173.4m. Powell Industries shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. One positive for Powell Industries shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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 Powell Industries' Profit Performance

As we discussed above, we think Powell Industries' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Powell Industries' 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 by 68% in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing Powell Industries at this point in time. At Simply Wall St, we found 1 warning sign for Powell Industries and we think they deserve your attention.

This note has only looked at a single factor that sheds light on the nature of Powell Industries' profit. But there are plenty of other ways to inform your opinion of a company. 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 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.