Lululemon Athletica's (NASDAQ:LULU) Earnings Are Growing But Is There More To The Story?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Lululemon Athletica's (NASDAQ:LULU) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Lululemon Athletica made a profit of US$566.0m on revenue of US$3.75b. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

View our latest analysis for Lululemon Athletica

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what Lululemon Athletica's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. 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.

A Closer Look At Lululemon Athletica's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. 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. 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.

Lululemon Athletica has an accrual ratio of 0.37 for the year to November 2019. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. In fact, it had free cash flow of US$238m in the last year, which was a lot less than its statutory profit of US$566.0m. Lululemon Athletica 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 Lululemon Athletica 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.

Our Take On Lululemon Athletica's Profit Performance

As we have made quite clear, we're a bit worried that Lululemon Athletica didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Lululemon Athletica's underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Ultimately, this article has formed an opinion based on historical data. However, it can also be great to think about what analysts are forecasting for the future. So feel free to check out our free graph representing analyst forecasts.

This note has only looked at a single factor that sheds light on the nature of Lululemon Athletica'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. 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.