Some Investors May Be Willing To Look Past Embecta's (NASDAQ:EMBC) Soft Earnings

The most recent earnings report from Embecta Corp. (NASDAQ:EMBC) was disappointing for shareholders. While the headline numbers were soft, we believe that investors might be missing some encouraging factors.

View our latest analysis for Embecta

A Closer Look At Embecta'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). 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 June 2022, Embecta had an accrual ratio of -0.14. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of US$411m, well over the US$337.9m it reported in profit. Embecta did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

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 Embecta's Profit Performance

As we discussed above, Embecta has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Embecta's statutory profit actually understates its earnings potential! 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. 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. When we did our research, we found 4 warning signs for Embecta (1 is significant!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Embecta's profit. 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. 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.