The subdued stock price reaction suggests that La Jolla Pharmaceutical Company's (NASDAQ:LJPC) strong earnings didn't offer any surprises. Investors are probably missing some underlying factors which are encouraging for the future of the company.
Examining Cashflow Against La Jolla Pharmaceutical'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). 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.
La Jolla Pharmaceutical has an accrual ratio of -0.47 for the year to September 2021. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of US$18m in the last year, which was a lot more than its statutory profit of US$12.4m. Given that La Jolla Pharmaceutical had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$18m 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 La Jolla Pharmaceutical's Profit Performance
Happily for shareholders, La Jolla Pharmaceutical produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think La Jolla Pharmaceutical's 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. 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. If you'd like to know more about La Jolla Pharmaceutical as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 2 warning signs for La Jolla Pharmaceutical you should be aware of.
Today we've zoomed in on a single data point to better understand the nature of La Jolla Pharmaceutical'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.
What are the risks and opportunities for La Jolla Pharmaceutical?
Trading at 78.6% below our estimate of its fair value
Earnings are forecast to grow 59.04% per year
Earnings have grown 40.6% per year over the past 5 years
Debt is not well covered by operating cash flow
Highly volatile share price over the past 3 months
Negative shareholders equity
Large one-off items impacting financial results
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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