Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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 Lattice Semiconductor's (NASDAQ:LSCC) statutory profits are a good guide to its underlying earnings.
While Lattice Semiconductor was able to generate revenue of US$401.2m in the last twelve months, we think its profit result of US$45.4m was more important. Even though revenue is down over the last three years, you can see in the chart below that the company has moved from loss-making to profitable.
Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. Therefore, we think it's worth taking a closer look at Lattice Semiconductor's cashflow, as well as examining the impact that unusual items have had on its reported profit. 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.
Zooming In On Lattice Semiconductor'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. This ratio tells us how much of a company's profit is not backed by free cashflow.
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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Lattice Semiconductor has an accrual ratio of -0.11 for the year to September 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of US$84m during the period, dwarfing its reported profit of US$45.4m. Lattice Semiconductor's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.
The Impact Of Unusual Items On Profit
Lattice Semiconductor's profit was reduced by unusual items worth US$8.6m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Lattice Semiconductor doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.
Our Take On Lattice Semiconductor's Profit Performance
Considering both Lattice Semiconductor's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Based on these factors, we think Lattice Semiconductor's earnings potential is at least as good as it seems, and maybe even better! 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 3 warning signs with Lattice Semiconductor, and understanding these should be part of your investment process.
After our examination into the nature of Lattice Semiconductor's profit, we've come away optimistic for the company. 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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This article by Simply Wall St is general in nature. 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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