The subdued market reaction suggests that GreenSky, Inc.'s (NASDAQ:GSKY) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.
A Closer Look At GreenSky'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
GreenSky has an accrual ratio of 5.13 for the year to March 2021. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of US$279m, in contrast to the aforementioned profit of US$17.1m. It's worth noting that GreenSky generated positive FCF of US$136m a year ago, so at least they've done it in the past. One positive for GreenSky 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 GreenSky's Profit Performance
As we have made quite clear, we're a bit worried that GreenSky didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that GreenSky's underlying earnings power is lower than its statutory profit. In further bad news, its earnings per share decreased in the last year. 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. If you'd like to know more about GreenSky as a business, it's important to be aware of any risks it's facing. For example, we've found that GreenSky has 5 warning signs (2 shouldn't be ignored!) that deserve your attention before going any further with your analysis.
This note has only looked at a single factor that sheds light on the nature of GreenSky's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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. 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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