Even though Woolworths Group Limited (ASX:WOW ) posted strong earnings, investors appeared to be underwhelmed. We did some digging and actually think they are being unnecessarily pessimistic.
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. You could think of the accrual ratio from cashflow as the ‘non-FCF profit ratio’.
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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Woolworths Group has an accrual ratio of -0.12 for the year to June 2025. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of AU$2.0b in the last year, which was a lot more than its statutory profit of AU$963.0m. Woolworths Group’s free cash flow improved over the last year, which is generally good to see. However, that’s not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.
Check out our latest analysis for Woolworths Group
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.
Woolworths Group’s profit was reduced by unusual items worth AU$569m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we’d expect to see a strong accrual ratio, which is exactly what has happened in this case. 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 Woolworths Group doesn’t see those unusual expenses repeat, then all else being equal we’d expect its profit to increase over the coming year.
Read More: Solid Earnings Reflect Woolworths Group’s (ASX:WOW) Strength As A Business
