Statutory Earnings May Not Be The Best Way To Understand General Shopping e Outlets do Brasil's (BVMF:GSHP3) True Position

Strong earnings weren't enough to please General Shopping e Outlets do Brasil S.A.'s (BVMF:GSHP3) shareholders over the last week. We did some analysis and believe that they might be concerned about some weak underlying factors.

Check out our latest analysis for General Shopping e Outlets do Brasil

Zooming In On General Shopping e Outlets do Brasil'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. 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.

General Shopping e Outlets do Brasil has an accrual ratio of 0.25 for the year to December 2023. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of R$93.2m, a look at free cash flow indicates it actually burnt through R$183m in the last year. We also note that General Shopping e Outlets do Brasil's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of R$183m. Importantly, we note an unusual tax situation, which we discuss below, has impacted the accruals ratio. This would partially explain why the accrual ratio was so poor.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of General Shopping e Outlets do Brasil.

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that General Shopping e Outlets do Brasil received a tax benefit of R$88m. This is meaningful because companies usually pay tax rather than receive tax benefits. The receipt of a tax benefit is obviously a good thing, on its own. And since it previously lost money, it may well simply indicate the realisation of past tax losses. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth.

Our Take On General Shopping e Outlets do Brasil's Profit Performance

This year, General Shopping e Outlets do Brasil couldn't match its profit with cashflow. On top of that, the unsustainable nature of tax benefits mean that there's a chance profit may be lower next year, certainly in the absence of strong growth. For the reasons mentioned above, we think that a perfunctory glance at General Shopping e Outlets do Brasil's statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing General Shopping e Outlets do Brasil at this point in time. Case in point: We've spotted 5 warning signs for General Shopping e Outlets do Brasil you should be aware of.

Our examination of General Shopping e Outlets do Brasil has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.