Texas Pacific Land's (NYSE:TPL) Solid Profits Have Weak Fundamentals

Unsurprisingly, Texas Pacific Land Corporation's (NYSE:TPL) stock price was strong on the back of its healthy earnings report. However, we think that shareholders may be missing some concerning details in the numbers.

Check out our latest analysis for Texas Pacific Land

Examining Cashflow Against Texas Pacific Land'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). 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. The ratio shows us how much a company's profit exceeds its FCF.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, Texas Pacific Land recorded an accrual ratio of 0.28. Unfortunately, that means its free cash flow fell significantly short of its reported profits. To wit, it produced free cash flow of US$334m during the period, falling well short of its reported profit of US$448.7m. Texas Pacific Land shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. The good news for shareholders is that Texas Pacific Land's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Texas Pacific Land.

Our Take On Texas Pacific Land's Profit Performance

Texas Pacific Land's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Texas Pacific Land's statutory profits are better than its underlying earnings power. But the good news is that its EPS growth over the last three years has been very impressive. 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. In terms of investment risks, we've identified 1 warning sign with Texas Pacific Land, and understanding it should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Texas Pacific Land'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. 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 with significant insider holdings to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.