In This Article:
The market was pleased with the recent earnings report from Adeia Inc. (NASDAQ:ADEA), despite the profit numbers being soft. Our analysis suggests that investors may have noticed some promising signs beyond the statutory profit figures.
Check out our latest analysis for Adeia
A Closer Look At Adeia's Earnings
In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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".
Adeia has an accrual ratio of -0.15 for the year to December 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of US$190m, well over the US$64.6m it reported in profit. Adeia's free cash flow improved over the last year, which is generally good to see.
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 Adeia's Profit Performance
As we discussed above, Adeia has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Adeia's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Adeia, you'd also look into what risks it is currently facing. In terms of investment risks, we've identified 1 warning sign with Adeia, and understanding this should be part of your investment process.