PulteGroup’s (NYSE:PHM) Solid Profits Have Weak Fundamentals

PulteGroup, Inc.’s (NYSE:PHM) stock was strong after they recently reported robust earnings. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

Our analysis indicates that PHM is potentially undervalued!

Examining Cashflow Against PulteGroup’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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2022, PulteGroup had an accrual ratio of 0.25. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Indeed, in the last twelve months it reported free cash flow of US$43m, which is significantly less than its profit of US$2.38b. PulteGroup’s free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits.

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 PulteGroup’s Profit Performance

PulteGroup’s accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that PulteGroup’s true underlying earnings power is actually less than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. Of course, we’ve only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. In light of this, if you’d like to do more analysis on the company, it’s vital to be informed of the risks involved. You’d be interested to know, that we found 2 warning signs for PulteGroup and you’ll want to know about these.

Today we’ve zoomed in on a single data point to better understand the nature of PulteGroup’s profit. But there are plenty of other ways to inform your opinion of a company. 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 that insiders are buying.

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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.