Why Stem's (NYSE:STEM) Healthy Earnings Aren’t As Good As They Seem

Stem, Inc.'s (NYSE:STEM) solid earnings report last week was underwhelming to investors. We think that they may be worried about something else, so we did some analysis and found that investors have noticed some soft numbers underlying the profit.

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A Closer Look At Stem'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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2025, Stem had an accrual ratio of 1.04. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of US$24m, in contrast to the aforementioned profit of US$102.6m. We also note that Stem's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$24m. 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. One positive for Stem 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.

Check out our latest analysis for Stem

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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Stem's profit was boosted by unusual items worth US$194m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Stem's positive unusual items were quite significant relative to its profit in the year to September 2025. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Stem's Profit Performance

Summing up, Stem received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. On reflection, the above-mentioned factors give us the strong impression that Stem'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. So while earnings quality is important, it's equally important to consider the risks facing Stem at this point in time. While conducting our analysis, we found that Stem has 5 warning signs and it would be unwise to ignore these.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.