We Think That There Are Issues Underlying Canaan's (NASDAQ:CAN) Earnings

Despite posting some strong earnings, the market for Canaan Inc.'s (NASDAQ:CAN) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for Canaan

A Closer Look At Canaan'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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

Over the twelve months to December 2021, Canaan recorded an accrual ratio of 1.52. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. Indeed, in the last twelve months it reported free cash flow of CN¥1.4b, which is significantly less than its profit of CN¥2.00b. We note, however, that Canaan grew its free cash flow over the last year. The good news for shareholders is that Canaan's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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 Canaan's Profit Performance

As we have made quite clear, we're a bit worried that Canaan didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Canaan's underlying earnings power is lower than its statutory profit. On the bright side, the company showed enough improvement to book a profit this year, after losing money 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that Canaan is showing 2 warning signs in our investment analysis and 1 of those can't be ignored...

Today we've zoomed in on a single data point to better understand the nature of Canaan's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.