Shareholders Can Be Confident That Collegium Pharmaceutical's (NASDAQ:COLL) Earnings Are High Quality

Collegium Pharmaceutical, Inc.'s (NASDAQ:COLL) 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.

View our latest analysis for Collegium Pharmaceutical

Zooming In On Collegium Pharmaceutical's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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".

Collegium Pharmaceutical has an accrual ratio of -0.13 for the year to September 2024. 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$192m during the period, dwarfing its reported profit of US$88.6m. Collegium Pharmaceutical's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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.

How Do Unusual Items Influence Profit?

Collegium Pharmaceutical's profit was reduced by unusual items worth US$36m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Collegium Pharmaceutical to produce a higher profit next year, all else being equal.

Our Take On Collegium Pharmaceutical's Profit Performance

In conclusion, both Collegium Pharmaceutical's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Looking at all these factors, we'd say that Collegium Pharmaceutical's underlying earnings power is at least as good as the statutory numbers would make it seem. If you want to do dive deeper into Collegium Pharmaceutical, you'd also look into what risks it is currently facing. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of Collegium Pharmaceutical.

Our examination of Collegium Pharmaceutical has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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. 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.