The most recent earnings report from NetSol Technologies, Inc. (NASDAQ:NTWK) was disappointing for shareholders. However, our analysis suggests that the soft headline numbers are getting counterbalanced by some positive underlying factors.
Examining Cashflow Against NetSol Technologies' Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Over the twelve months to December 2020, NetSol Technologies recorded an accrual ratio of -0.18. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of US$11m during the period, dwarfing its reported profit of US$2.65m. NetSol Technologies shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of NetSol Technologies.
Our Take On NetSol Technologies' Profit Performance
Happily for shareholders, NetSol Technologies produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that NetSol Technologies' statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about NetSol Technologies as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 2 warning signs for NetSol Technologies you should know about.
This note has only looked at a single factor that sheds light on the nature of NetSol Technologies' profit. But there are plenty of other ways to inform your opinion of a company. 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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