Broadly speaking, profitable businesses are less risky than unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we’ll look at how useful this year’s statutory profit is, when analysing M1 Kliniken (ETR:M12).
We like the fact that M1 Kliniken made a profit of €9.73m on its revenue of €77.2m, in the last year. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.
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. So today we’ll look at what M1 Kliniken’s cashflow and unusual items tell us about the quality of its 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.
Zooming In On M1 Kliniken’s 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). 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. This ratio tells us how much of a company’s profit is not backed by free cashflow.
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. To quote a 2014 paper by Lewellen and Resutek, “firms with higher accruals tend to be less profitable in the future”.
Over the twelve months to December 2019, M1 Kliniken recorded an accrual ratio of 0.38. Statistically speaking, that’s a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of €6.7m, in contrast to the aforementioned profit of €9.73m. We saw that FCF was €533k a year ago though, so M1 Kliniken has at least been able to generate positive FCF in the past. However, that’s not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
How Do Unusual Items Influence Profit?
Given the accrual ratio, it’s not overly surprising that M1 Kliniken’s profit was boosted by unusual items worth €3.4m in the last twelve months. We can’t deny that higher profits generally leave us optimistic, but we’d prefer it if the profit were to be sustainable. 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. We can see that M1 Kliniken’s positive unusual items were quite significant relative to its profit in the year to December 2019. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.
Our Take On M1 Kliniken’s Profit Performance
Summing up, M1 Kliniken received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at M1 Kliniken’s statutory profits might make it look better than it really is on an underlying level. With this in mind, we wouldn’t consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we’ve spotted 3 warning signs for M1 Kliniken (of which 1 doesn’t sit too well with us!) you should know about.
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 are plenty of other ways to inform your opinion of a company. 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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