Vanda Pharmaceuticals' (NASDAQ:VNDA) Sluggish Earnings Might Be Just The Beginning Of Its Problems

The market rallied behind Vanda Pharmaceuticals Inc.'s (NASDAQ:VNDA) stock, leading do a rise in the share price after its recent weak earnings report. While shareholders may be willing to overlook soft profit numbers, we believe that they should also be taking into account some other factors which may be cause for concern.

Check out our latest analysis for Vanda Pharmaceuticals

A Closer Look At Vanda Pharmaceuticals' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2023, Vanda Pharmaceuticals recorded an accrual ratio of 0.84. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of US$2.51m, a look at free cash flow indicates it actually burnt through US$88m in the last year. We saw that FCF was US$31m a year ago though, so Vanda Pharmaceuticals has at least been able to generate positive FCF in the past. One positive for Vanda Pharmaceuticals shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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 Vanda Pharmaceuticals' Profit Performance

As we discussed above, we think Vanda Pharmaceuticals' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Vanda Pharmaceuticals' underlying earnings power is lower than its statutory profit. Sadly, its EPS was down over the last twelve months. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've found that Vanda Pharmaceuticals has 3 warning signs (2 are a bit unpleasant!) 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 Vanda 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. 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.

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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.