Arrowhead Pharmaceuticals, Inc.'s (NASDAQ:ARWR) earnings announcement last week was disappointing for investors, despite the decent profit numbers. We did some digging and actually think they are being unnecessarily pessimistic.

Zooming In On Arrowhead Pharmaceuticals' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.

For the year to December 2025, Arrowhead Pharmaceuticals had an accrual ratio of -0.48. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of US$322m during the period, dwarfing its reported profit of US$202.3m. Notably, Arrowhead Pharmaceuticals had negative free cash flow last year, so the US$322m it produced this year was a welcome improvement. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Arrowhead Pharmaceuticals issued 11% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Arrowhead Pharmaceuticals' historical EPS growth by clicking on this link.

A Look At The Impact Of Arrowhead Pharmaceuticals' Dilution On Its Earnings Per Share (EPS)

Arrowhead Pharmaceuticals was losing money three years ago. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. What we do know is that while it's great to see a profit over the last twelve months, that profit would have been better, on a per share basis, if the company hadn't needed to issue shares. Therefore, the dilution is having a noteworthy influence on shareholder returns.

If Arrowhead Pharmaceuticals' EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Arrowhead Pharmaceuticals' Profit Performance

In conclusion, Arrowhead Pharmaceuticals has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Considering all the aforementioned, we'd venture that Arrowhead Pharmaceuticals' profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you want to do dive deeper into Arrowhead Pharmaceuticals, you'd also look into what risks it is currently facing.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there are plenty of other ways to inform your opinion of a company. 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.

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.