Some Investors May Be Willing To Look Past Workday's (NASDAQ:WDAY) Soft Earnings

Soft earnings didn't appear to concern Workday, Inc.'s (NASDAQ:WDAY) shareholders over the last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

View our latest analysis for Workday

Examining Cashflow Against Workday's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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".

Workday has an accrual ratio of -0.46 for the year to January 2025. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of US$2.2b during the period, dwarfing its reported profit of US$526.0m. Workday 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 Workday's Profit Performance

As we discussed above, Workday's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Workday's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in the last twelve months. 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 want to do dive deeper into Workday, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 1 warning sign with Workday, and understanding it should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of Workday'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 with high insider ownership.

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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.