Alphabet’s (NASDAQ:GOOGL) Earnings Are Weaker Than They Seem

Investors were disappointed with Alphabet Inc.’s (NASDAQ:GOOGL) earnings, despite the strong profit numbers. We think that the market might be paying attention to some underlying factors that they find to be concerning.

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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. 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’.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Alphabet has an accrual ratio of 0.20 for the year to December 2025. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. To wit, it produced free cash flow of US$73b during the period, falling well short of its reported profit of US$132.2b. Notably Alphabet’s free cash flow was stable over the last year. 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.

See our latest analysis for Alphabet

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.

Given the accrual ratio, it’s not overly surprising that Alphabet’s profit was boosted by unusual items worth US$25b in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If Alphabet doesn’t see that contribution repeat, then all else being equal we’d expect its profit to drop over the current year.

Alphabet had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we’d argue Alphabet’s profits probably give an overly generous impression of its sustainable level of profitability. If you’d like to know more about Alphabet as a business, it’s important to be aware of any risks it’s facing. At Simply Wall St, we found 1 warning sign for Alphabet and we think they deserve your attention.

In this article we’ve looked at a number of factors that can impair the utility of profit numbers, and we’ve come away cautious. 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.