The recent earnings posted by Meritage Homes Corporation (NYSE:MTH) were solid, but the stock didn't move as much as we expected. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

See our latest analysis for Meritage Homes

Zooming In On Meritage Homes' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Meritage Homes has an accrual ratio of 0.22 for the year to September 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of US$261m despite its profit of US$812.4m, mentioned above. It's worth noting that Meritage Homes generated positive FCF of US$997m a year ago, so at least they've done it in the past. The good news for shareholders is that Meritage Homes' 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. 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 Meritage Homes' Profit Performance

Meritage Homes didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Meritage Homes' statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 29% over the last three years. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. When we did our research, we found 3 warning signs for Meritage Homes (1 is a bit unpleasant!) that we believe deserve your full attention.