Investors were underwhelmed by the solid earnings posted by Tilly's, Inc. (NYSE:TLYS) recently. We have done some analysis and have found some comforting factors beneath the profit numbers.
Examining Cashflow Against Tilly'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). 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.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
For the year to May 2021, Tilly's had an accrual ratio of -1.11. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of US$67m in the last year, which was a lot more than its statutory profit of US$27.2m. Tilly's' free cash flow improved over the last year, which is generally good to see.
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 Tilly's' Profit Performance
Happily for shareholders, Tilly's produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Tilly's' statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate over the 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. In terms of investment risks, we've identified 2 warning signs with Tilly's, and understanding them should be part of your investment process.
Today we've zoomed in on a single data point to better understand the nature of Tilly's' 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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