As a general rule, we think profitable companies are less risky than companies that lose money. 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. Today we’ll focus on whether this year’s statutory profits are a good guide to understanding Momentum Group (STO:MMGR B).
It’s good to see that over the last twelve months Momentum Group made a profit of kr256.0m on revenue of kr6.85b. In the chart below, you can see that its profit and revenue have both grown over the last three years.
Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we’ll look at what Momentum Group’s cashflow tells us about its earnings, as well as examining how issuing shares is impacting shareholder value. 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.
A Closer Look At Momentum Group’s Earnings
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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company’s average operating assets over that period. 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.
Momentum Group has an accrual ratio of -0.15 for the year to June 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of kr741m in the last year, which was a lot more than its statutory profit of kr256.0m. Momentum Group’s free cash flow improved over the last year, which is generally good to see. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.
One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Momentum Group expanded the number of shares on issue by 82% over the last year. As a result, its net income is now split between a greater number of shares. 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 Momentum Group’s historical EPS growth by clicking on this link.
How Is Dilution Impacting Momentum Group’s Earnings Per Share? (EPS)
Momentum Group has improved its profit over the last three years, with an annualized gain of 673% in that time. In comparison, earnings per share only gained 553% over the same period. And in the last year the company managed to bump profit up by 13%. But earnings per share are actually down 5.6%, over the last twelve months. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.
In the long term, if Momentum Group’s earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical “share” of the company’s profit.
Our Take On Momentum Group’s Profit Performance
In conclusion, Momentum Group 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. Based on these factors, we think it’s very unlikely that Momentum Group’s statutory profits make it seem much weaker than it is. So if you’d like to dive deeper into this stock, it’s crucial to consider any risks it’s facing. For example, Momentum Group has 2 warning signs (and 1 which doesn’t sit too well with us) we think you should know about.
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 that insiders are buying to be useful.
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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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