Are CanWel Building Materials Group’s (TSE:CWX) Statutory Earnings A Good Guide To Its Underlying Profitability?

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company’s underlying profitability. Today we’ll focus on whether this year’s statutory profits are a good guide to understanding CanWel Building Materials Group (TSE:CWX).

While CanWel Building Materials Group was able to generate revenue of CA$1.41b in the last twelve months, we think its profit result of CA$23.3m was more important. As shown in the chart below, it did manage to grow its revenue over the last three years, although its profit has been pretty flat.

Check out our latest analysis for CanWel Building Materials Group

earnings-and-revenue-history
TSX:CWX Earnings and Revenue History August 29th 2020

Importantly, statutory profits are not always the best tool for understanding a company’s true earnings power, so it’s well worth examining profits in a little more detail. As a result, we think it’s well worth considering what CanWel Building Materials Group’s cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. 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.

Zooming In On CanWel Building Materials Group’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. This ratio tells us how much of a company’s profit is not backed by free cashflow.

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. To quote a 2014 paper by Lewellen and Resutek, “firms with higher accruals tend to be less profitable in the future”.

For the year to June 2020, CanWel Building Materials Group had an accrual ratio of -0.18. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of CA$151m, well over the CA$23.3m it reported in profit. CanWel Building Materials Group shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On CanWel Building Materials Group’s Profit Performance

Happily for shareholders, CanWel Building Materials Group produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think CanWel Building Materials Group’s underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 43% over the last twelve months. Of course, we’ve only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you’d like to dive deeper into this stock, it’s crucial to consider any risks it’s facing. To help with this, we’ve discovered 3 warning signs (1 can’t be ignored!) that you ought to be aware of before buying any shares in CanWel Building Materials Group.

This note has only looked at a single factor that sheds light on the nature of CanWel Building Materials Group’s profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to ‘follow the money’ and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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This article by Simply Wall St is general in nature. 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.
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