Vital Farms' (NASDAQ:VITL) Performance Is Even Better Than Its Earnings Suggest

Vital Farms, Inc.'s (NASDAQ:VITL) earnings announcement last week was disappointing for investors, despite the decent profit numbers. We have done some analysis and have found some comforting factors beneath the profit numbers.

Check out our latest analysis for Vital Farms

Examining Cashflow Against Vital Farms' 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. 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 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.

For the year to September 2024, Vital Farms had an accrual ratio of -0.12. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of US$61m during the period, dwarfing its reported profit of US$50.0m. Vital Farms' free cash flow improved over the last year, which is generally good to see. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

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.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Vital Farms expanded the number of shares on issue by 5.3% over the last year. As a result, its net income is now split between a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Vital Farms' historical EPS growth by clicking on this link.

How Is Dilution Impacting Vital Farms' Earnings Per Share (EPS)?

As it happens, we don't know how much the company made or lost three years ago, because we don't have the data. The good news is that profit was up 144% in the last twelve months. On the other hand, earnings per share are only up 136% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Vital Farms can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Vital Farms' Profit Performance

At the end of the day, Vital Farms is diluting shareholders which will dampen earnings per share growth, but its accrual ratio showed it can back up its profits with free cash flow. After taking into account all these factors, we think that Vital Farms' statutory results are a decent reflection of its underlying earnings power. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. In terms of investment risks, we've identified 1 warning sign with Vital Farms, and understanding this should be part of your investment process.

Our examination of Vital Farms has focussed on certain factors that can make its earnings look better than they are. 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.

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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.