Is There More To The Story Than Beacon Lighting Group's (ASX:BLX) Earnings Growth?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Beacon Lighting Group's (ASX:BLX) statutory profits are a good guide to its underlying earnings.

While Beacon Lighting Group was able to generate revenue of AU$253.3m in the last twelve months, we think its profit result of AU$22.2m was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years.

Check out our latest analysis for Beacon Lighting Group

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, today we're going to take a closer look at Beacon Lighting Group's cashflow, and unusual items, with a view to understanding what these might tell us about 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.

A Closer Look At Beacon Lighting Group's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

Over the twelve months to June 2020, Beacon Lighting Group recorded an accrual ratio of -0.28. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of AU$49m during the period, dwarfing its reported profit of AU$22.2m. Given that Beacon Lighting Group had negative free cash flow in the prior corresponding period, the trailing twelve month resul of AU$49m would seem to be a step in the right direction. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Beacon Lighting Group's profit was boosted by unusual items worth AU$7.8m 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. If Beacon Lighting Group doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Beacon Lighting Group's Profit Performance

In conclusion, Beacon Lighting Group's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering all the aforementioned, we'd venture that Beacon Lighting Group's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you'd like to know more about Beacon Lighting Group as a business, it's important to be aware of any risks it's facing. While conducting our analysis, we found that Beacon Lighting Group has 3 warning signs and it would be unwise to ignore them.

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. 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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