The latest earnings release from Roivant Sciences Ltd. (NASDAQ:ROIV ) disappointed investors. We did some analysis and believe that they might be concerned about some weak underlying factors.

Check out our latest analysis for Roivant Sciences

A Closer Look At Roivant Sciences' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

For the year to September 2024, Roivant Sciences had an accrual ratio of 19.58. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of US$781m, in contrast to the aforementioned profit of US$4.60b. We also note that Roivant Sciences' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$781m. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. The good news for shareholders is that Roivant Sciences' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Roivant Sciences' profit was boosted by unusual items worth US$5.5b in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. Roivant Sciences had a rather significant contribution from unusual items relative to its profit to September 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Roivant Sciences' Profit Performance

Summing up, Roivant Sciences received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For all the reasons mentioned above, we think that, at a glance, Roivant Sciences' statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To help with this, we've discovered 3 warning signs (2 are significant!) that you ought to be aware of before buying any shares in Roivant Sciences.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.