Best&Less Group Holdings' (ASX:BST) Soft Earnings Don't Show The Whole Picture

Shareholders appeared unconcerned with Best&Less Group Holdings Ltd's (ASX:BST) lackluster earnings report last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

See our latest analysis for Best&Less Group Holdings

Zooming In On Best&Less Group Holdings' 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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.

For the year to December 2021, Best&Less Group Holdings had an accrual ratio of -1.51. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of AU$59m during the period, dwarfing its reported profit of AU$33.2m. Best&Less Group Holdings did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie. 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.

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.

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that Best&Less Group Holdings' profit was boosted by unusual items worth AU$9.4m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Best&Less Group Holdings' Profit Performance

In conclusion, Best&Less Group Holdings' accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Based on these factors, we think that Best&Less Group Holdings' profits are a reasonably conservative guide to its underlying profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example - Best&Less Group Holdings has 3 warning signs we think you should be aware of.

Our examination of Best&Less Group Holdings has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.