Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Pliant Therapeutics' (NASDAQ:PLRX) statutory profits are a good guide to its underlying earnings.
It's good to see that over the last twelve months Pliant Therapeutics made a profit of US$17.5m on revenue of US$94.4m.
Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Pliant Therapeutics' cashflow tells us about the quality of its earnings. 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.
Examining Cashflow Against Pliant Therapeutics' Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.
Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Over the twelve months to September 2020, Pliant Therapeutics recorded an accrual ratio of 0.52. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. In fact, it had free cash flow of US$15m in the last year, which was a lot less than its statutory profit of US$17.5m. Given that Pliant Therapeutics had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$15m would seem to be a step in the right direction.
Our Take On Pliant Therapeutics' Profit Performance
As we have made quite clear, we're a bit worried that Pliant Therapeutics didn't back up the last year's profit with free cashflow. For this reason, we think that Pliant Therapeutics' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. On the bright side, the company showed enough improvement to book a profit this year, after 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. If you want to do dive deeper into Pliant Therapeutics, you'd also look into what risks it is currently facing. For instance, we've identified 3 warning signs for Pliant Therapeutics (2 are a bit concerning) you should be familiar with.
This note has only looked at a single factor that sheds light on the nature of Pliant Therapeutics' 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.
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