There May Be Underlying Issues With The Quality Of OSI Systems' (NASDAQ:OSIS) Earnings

Despite announcing strong earnings, OSI Systems, Inc.'s (NASDAQ:OSIS) stock was sluggish. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

See our latest analysis for OSI Systems

Examining Cashflow Against OSI Systems' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, OSI Systems recorded an accrual ratio of 0.26. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of US$184m, in contrast to the aforementioned profit of US$133.2m. We saw that FCF was US$60m a year ago though, so OSI Systems has at least been able to generate positive FCF in the past.

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 OSI Systems' Profit Performance

OSI Systems didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that OSI Systems' statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 68% per annum growth in EPS for the last three. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example, we've found that OSI Systems has 3 warning signs (2 can't be ignored!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of OSI Systems' 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 with significant insider holdings to be useful.

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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.