Lavvi Empreendimentos Imobiliários' (BVMF:LAVV3) Attractive Earnings Are Not All Good News For Shareholders

Lavvi Empreendimentos Imobiliários S.A.'s (BVMF:LAVV3) stock rose after it released a robust earnings report. Despite the strong profit numbers, we believe that there are some deeper issues which investors should look into.

View our latest analysis for Lavvi Empreendimentos Imobiliários

Examining Cashflow Against Lavvi Empreendimentos Imobiliários' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Lavvi Empreendimentos Imobiliários has an accrual ratio of 0.46 for the year to December 2023. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of R$231.4m, a look at free cash flow indicates it actually burnt through R$263m in the last year. It's worth noting that Lavvi Empreendimentos Imobiliários generated positive FCF of R$80m a year ago, so at least they've done it in the past. 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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Lavvi Empreendimentos Imobiliários' profit was boosted by unusual items worth R$47m 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 analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. 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 Lavvi Empreendimentos Imobiliários' Profit Performance

Lavvi Empreendimentos Imobiliários had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Lavvi Empreendimentos Imobiliários' statutory profits might make it look better than it really is on an underlying level. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that Lavvi Empreendimentos Imobiliários is showing 2 warning signs in our investment analysis and 1 of those makes us a bit uncomfortable...

Our examination of Lavvi Empreendimentos Imobiliários 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. 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. 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.