Here's Why We Think Pacific Smiles Group's (ASX:PSQ) Statutory Earnings Might Be Conservative

As a general rule, we think profitable companies are less risky than companies that lose money. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Pacific Smiles Group (ASX:PSQ).

We like the fact that Pacific Smiles Group made a profit of AU$6.38m on its revenue of AU$120.1m, in the last year. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

View our latest analysis for Pacific Smiles Group

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 Pacific Smiles 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.

Examining Cashflow Against Pacific Smiles 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. 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. 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Pacific Smiles Group has an accrual ratio of -0.25 for the year to June 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of AU$18m during the period, dwarfing its reported profit of AU$6.38m. Pacific Smiles Group shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Pacific Smiles Group's Profit Performance

As we discussed above, Pacific Smiles Group's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Pacific Smiles Group's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in 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 while earnings quality is important, it's equally important to consider the risks facing Pacific Smiles Group at this point in time. Every company has risks, and we've spotted 2 warning signs for Pacific Smiles Group you should know about.

Today we've zoomed in on a single data point to better understand the nature of Pacific Smiles Group's profit. 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. 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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