The subdued stock price reaction suggests that Tandem Diabetes Care, Inc.'s (NASDAQ:TNDM) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.
A Closer Look At Tandem Diabetes Care's Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Tandem Diabetes Care has an accrual ratio of -0.93 for the year to June 2021. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of US$62m, well over the US$6.56m it reported in profit. Tandem Diabetes Care shareholders are no doubt pleased that free cash flow improved over the last twelve months.
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 Tandem Diabetes Care's Profit Performance
As we discussed above, Tandem Diabetes Care's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Tandem Diabetes Care's statutory profit actually understates its earnings potential! And one can definitely find a positive in the fact that it made a profit this year, despite losing money last year. 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. If you'd like to know more about Tandem Diabetes Care as a business, it's important to be aware of any risks it's facing. For example, we've found that Tandem Diabetes Care has 4 warning signs (1 is concerning!) that deserve your attention before going any further with your analysis.
Today we've zoomed in on a single data point to better understand the nature of Tandem Diabetes Care'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. 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.
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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.
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