Investors Can Find Comfort In Lam Research's (NASDAQ:LRCX) Earnings Quality

The market for Lam Research Corporation's (NASDAQ:LRCX) shares didn't move much after it posted weak earnings recently. We did some digging, and we believe the earnings are stronger than they seem.

See our latest analysis for Lam Research

Zooming In On Lam Research's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to December 2023, Lam Research had an accrual ratio of -0.17. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of US$4.9b during the period, dwarfing its reported profit of US$3.46b. Lam Research shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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 Lam Research's Profit Performance

As we discussed above, Lam Research's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Lam Research's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 27% annually, over the last three years. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. In terms of investment risks, we've identified 1 warning sign with Lam Research, and understanding this should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of Lam Research'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. 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.