EN
We Think Freshworks' (NASDAQ:FRSH) Profit Is Only A Baseline For What They Can Achieve
Despite announcing strong earnings, Freshworks Inc.'s (NASDAQ:FRSH) stock was sluggish. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.
A Closer Look At Freshworks' Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Freshworks has an accrual ratio of -0.22 for the year to September 2026. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of US$236m in the last year, which was a lot more than its statutory profit of US$208.2m. Freshworks' free cash flow improved over the last year, which is generally good to see. However, as we will discuss below, we can see that the company's accrual ratio has been impacted by its tax situation.
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.
An Unusual Tax Situation
In addition to the notable accrual ratio, we can see that Freshworks received a tax benefit of US$125m. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! The receipt of a tax benefit is obviously a good thing, on its own. And since it previously lost money, it may well simply indicate the realisation of past tax losses. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth.
Our Take On Freshworks' Profit Performance
In conclusion, Freshworks has strong cashflow relative to earnings, which indicates good quality earnings, but the tax benefit means its profit wasn't as sustainable as we'd like to see. Given the contrasting considerations, we don't have a strong view as to whether Freshworks's profits are an apt reflection of its underlying potential for profit. 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. For example, we've found that Freshworks has 2 warning signs (1 shouldn't be ignored!) that deserve your attention before going any further with your analysis.
Our examination of Freshworks has focussed on certain factors that can make its earnings look better than they are. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.