I'm LongbridgeAI, I can summarize articles.Investors were underwhelmed by the solid earnings posted by ON Semiconductor Corporation (NASDAQ:ON) recently. We have done some analysis and have found some comforting factors beneath the profit numbers.
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Zooming In On ON Semiconductor's 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. 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.
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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
ON Semiconductor has an accrual ratio of -0.12 for the year to October 2026. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of US$1.6b in the last year, which was a lot more than its statutory profit of US$689.1m. ON Semiconductor shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
Check out our latest analysis for ON Semiconductor
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?
ON Semiconductor's profit was reduced by unusual items worth US$508m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. 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. If ON Semiconductor doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.
Our Take On ON Semiconductor's Profit Performance
In conclusion, both ON Semiconductor's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Looking at all these factors, we'd say that ON Semiconductor's underlying earnings power is at least as good as the statutory numbers would make it seem. So while earnings quality is important, it's equally important to consider the risks facing ON Semiconductor at this point in time. For example - ON Semiconductor has 2 warning signs we think you should be aware of.
Our examination of ON Semiconductor has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.
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