A lackluster earnings announcement from Pilbara Minerals Limited (ASX:PLS) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.

See our latest analysis for Pilbara Minerals

Zooming In On Pilbara Minerals' 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. 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. 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 June 2024, Pilbara Minerals recorded an accrual ratio of 1.23. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of AU$1.3b, in contrast to the aforementioned profit of AU$256.9m. It's worth noting that Pilbara Minerals generated positive FCF of AU$3.1b a year ago, so at least they've done it in the past. One positive for Pilbara Minerals shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. 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 Pilbara Minerals' Profit Performance

As we discussed above, we think Pilbara Minerals' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Pilbara Minerals' underlying earnings power is lower than its statutory profit. In further bad news, its earnings per share decreased in the last year. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To that end, you should learn about the 2 warning signs we've spotted with Pilbara Minerals (including 1 which is a bit unpleasant).