What happened

Shares of Nuance Communications (NASDAQ:NUAN), maker of the popular Dragon Naturally Speaking family of voice-to-text (and text-to-voice) software products, are surging, up 14.3% in Thursday-morning trading circa 11:15 a.m. EST. These gains are coming after Nuance announced a modest earnings "beat" in its earnings report last night -- and despite Nuance's warning of an even bigger earnings miss in the coming year.  

So what

Expected to report pro forma profits of only $0.16 per share on sales of $345.7 million in its fiscal fourth quarter 2020, Nuance actually reported adjusted profits of $0.18 on sales of $352.9 million.  

That's the good news. Now here's the bad: Sales may have exceeded expectations, but they were nonetheless down 9% year over year. Operating profit margins on those sales fell by more than half, landing at just 3.7%, and while the company "beat" earnings expectations on a pro forma basis, its actual results as calculated according to generally accepted accounting principles (GAAP) were an $0.08-per-share loss -- versus $0.01 per share in profit in last year's Q4.

A cartoon professor with a pointer indicates a rising stock arrow.

Image source: Getty Images.

Now what

It gets worse. Guiding for what to expect in fiscal 2021, currently underway, Nuance told investors on its conference call -- but not in its earnings report proper -- that it will earn only $0.71 to $0.77 (and again, only pro forma) versus analyst forecasts of $0.87. Sales, too, look likely to fall below estimates, with Nuance's forecast for no more than $1.37 billion in 2021 revenue likely to fall 10% short of the consensus estimate on Wall Street.

One final note: Free cash flow at the software company came in at a respectable $65.1 million in real cash profit generated in the year's fourth quarter and $193.3 million generated for the year. Like all the other numbers, however, these tallies were worse than last year's -- and they leave the stock trading at a nosebleed valuation of 57 times trailing FCF and 44 times even the most optimistic estimates for next year's FCF as well.

Sad to say, I fear investors who are buying up Nuance stock on this report are making a serious mistake.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.