Shareholders appeared unconcerned with SAP SE's (ETR:SAP) lackluster earnings report last week. We did some digging, and we believe the earnings are stronger than they seem.

See our latest analysis for SAP

Zooming In On SAP's Earnings

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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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, SAP recorded an accrual ratio of -0.10. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of €7.0b during the period, dwarfing its reported profit of €2.75b. SAP shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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.

How Do Unusual Items Influence Profit?

SAP's profit was reduced by unusual items worth €3.5b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. SAP took a rather significant hit from unusual items in the year to September 2024. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On SAP's Profit Performance

In conclusion, both SAP's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think SAP's earnings potential is at least as good as it seems, and maybe even better! So while earnings quality is important, it's equally important to consider the risks facing SAP at this point in time. In terms of investment risks, we've identified 1 warning sign with SAP, and understanding this should be part of your investment process.