MSC Industrial Direct's (NYSE:MSM) Soft Earnings Are Actually Better Than They Appear

The market for MSC Industrial Direct Co., Inc.'s (NYSE:MSM) shares didn't move much after it posted weak earnings recently. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Check out our latest analysis for MSC Industrial Direct

Examining Cashflow Against MSC Industrial Direct'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

MSC Industrial Direct has an accrual ratio of -0.14 for the year to December 2023. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of US$619m during the period, dwarfing its reported profit of US$331.3m. MSC Industrial Direct shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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 MSC Industrial Direct's Profit Performance

As we discussed above, MSC Industrial Direct has perfectly satisfactory free cash flow relative to profit. Because of this, we think MSC Industrial Direct's earnings potential is at least as good as it seems, and maybe even better! And the EPS is up 48% annually, over the last three years. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. In terms of investment risks, we've identified 1 warning sign with MSC Industrial Direct, and understanding this should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of MSC Industrial Direct's 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. 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 that insiders are buying 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.