Eton Pharmaceuticals' (NASDAQ:ETON) Earnings May Just Be The Starting Point

Eton Pharmaceuticals, Inc.'s (NASDAQ:ETON) earnings announcement last week was disappointing for investors, despite the decent profit numbers. We did some digging and actually think they are being unnecessarily pessimistic.

Check out our latest analysis for Eton Pharmaceuticals

Examining Cashflow Against Eton Pharmaceuticals' 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. 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. 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. 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.

Eton Pharmaceuticals has an accrual ratio of -2.96 for the year to September 2023. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of US$9.3m, well over the US$2.23m it reported in profit. Given that Eton Pharmaceuticals had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$9.3m would seem to be a step in the right direction.

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 Eton Pharmaceuticals' Profit Performance

As we discussed above, Eton Pharmaceuticals' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Eton Pharmaceuticals' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And one can definitely find a positive in the fact that it made a profit this year, despite losing money last year. 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. So while earnings quality is important, it's equally important to consider the risks facing Eton Pharmaceuticals at this point in time. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Eton Pharmaceuticals.

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

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.