Shareholders appeared unconcerned with Masco Corporation's (NYSE:MAS) lackluster earnings report last week. We did some digging, and we believe the earnings are stronger than they seem.
Examining Cashflow Against Masco'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.
Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Masco has an accrual ratio of -0.13 for the year to June 2021. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of US$780m during the period, dwarfing its reported profit of US$516.0m. Over the last year, Masco's free cash flow remained steady.
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 Masco's Profit Performance
As we discussed above, Masco has perfectly satisfactory free cash flow relative to profit. Because of this, we think Masco's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at 8.5% per year over the last three years. 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. 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. Every company has risks, and we've spotted 3 warning signs for Masco you should know about.
Today we've zoomed in on a single data point to better understand the nature of Masco'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.
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