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Following the solid earnings report from NETGEAR, Inc. (NASDAQ:NTGR), the market responded by bidding up the stock price. Despite this, our analysis suggests that there are some factors weakening the foundations of those good profit numbers.
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Examining Cashflow Against NETGEAR'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. 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.
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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
NETGEAR has an accrual ratio of -0.58 for the year to March 2025. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of US$131m, well over the US$25.0m it reported in profit. NETGEAR's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
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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.
The Impact Of Unusual Items On Profit
While the accrual ratio might bode well, we also note that NETGEAR's profit was boosted by unusual items worth US$85m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. NETGEAR had a rather significant contribution from unusual items relative to its profit to March 2025. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.