Here's Why Brisbane Broncos's (ASX:BBL) Statutory Earnings Are Arguably Too Conservative

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. This article will consider whether Brisbane Broncos' (ASX:BBL) statutory profits are a good guide to its underlying earnings.

While Brisbane Broncos was able to generate revenue of AU$28.3m in the last twelve months, we think its profit result of AU$1.38m was more important. The chart below shows that both revenue and profit have declined over the last three years.

Check out our latest analysis for Brisbane Broncos

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Brisbane Broncos' cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Brisbane Broncos.

Examining Cashflow Against Brisbane Broncos' 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. 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to June 2020, Brisbane Broncos had an accrual ratio of -0.21. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of AU$6.1m during the period, dwarfing its reported profit of AU$1.38m. Brisbane Broncos' free cash flow improved over the last year, which is generally good to see.

Our Take On Brisbane Broncos' Profit Performance

As we discussed above, Brisbane Broncos' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Brisbane Broncos' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 56% over the last twelve months. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you want to do dive deeper into Brisbane Broncos, you'd also look into what risks it is currently facing. For example, Brisbane Broncos has 3 warning signs (and 1 which is concerning) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Brisbane Broncos' profit. 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. 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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