Toro's (NASDAQ:TORO) Profits May Be Overstating Its True Earnings Potential

Shareholders were pleased with the recent earnings report from Toro Corp. (NASDAQ:TORO). Investors should be cautious however, as there some causes of concern deeper in the numbers.

Check out our latest analysis for Toro

A Closer Look At Toro'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Toro has an accrual ratio of 1.19 for the year to December 2023. 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. In the last twelve months it actually had negative free cash flow, with an outflow of US$16m despite its profit of US$137.0m, mentioned above. We saw that FCF was US$41m a year ago though, so Toro has at least been able to generate positive FCF in the past. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Toro.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Toro's profit was boosted by unusual items worth US$99m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. We can see that Toro's positive unusual items were quite significant relative to its profit in the year to December 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Toro's Profit Performance

Toro had a weak accrual ratio, but its profit did receive a boost from unusual items. On reflection, the above-mentioned factors give us the strong impression that Toro'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. 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. While conducting our analysis, we found that Toro has 2 warning signs and it would be unwise to ignore these.

Our examination of Toro has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 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.