When companies post strong earnings, the stock generally performs well, just like Catalyst Pharmaceuticals, Inc.'s (NASDAQ:CPRX) stock has recently. We have done some analysis, and we found several positive factors beyond the profit numbers.

View our latest analysis for Catalyst Pharmaceuticals

Examining Cashflow Against Catalyst Pharmaceuticals' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2024, Catalyst Pharmaceuticals recorded an accrual ratio of -0.19. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of US$186m during the period, dwarfing its reported profit of US$142.8m. Notably, Catalyst Pharmaceuticals had negative free cash flow last year, so the US$186m it produced this year was a welcome improvement. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Catalyst Pharmaceuticals issued 12% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of Catalyst Pharmaceuticals' EPS by clicking here.

A Look At The Impact Of Catalyst Pharmaceuticals' Dilution On Its Earnings Per Share (EPS)

Catalyst Pharmaceuticals has improved its profit over the last three years, with an annualized gain of 243% in that time. In comparison, earnings per share only gained 209% over the same period. And the 130% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 111% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Catalyst Pharmaceuticals can grow EPS persistently. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Catalyst Pharmaceuticals' Profit Performance

At the end of the day, Catalyst Pharmaceuticals is diluting shareholders which will dampen earnings per share growth, but its accrual ratio showed it can back up its profits with free cash flow. Considering all the aforementioned, we'd venture that Catalyst Pharmaceuticals' profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 2 warning signs for Catalyst Pharmaceuticals you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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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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.