Here's Why Grupo SBF's (BVMF:CNTO3) 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Grupo SBF (BVMF:CNTO3).

It's good to see that over the last twelve months Grupo SBF made a profit of R$37.0m on revenue of R$2.17b. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.

Check out our latest analysis for Grupo SBF

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 this article aims to better understand Grupo SBF's underlying earnings power by taking a look at how dilution, and unusual items are impacting it, and considering how well those paper profits are being converted into cash flow. 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 Grupo SBF's 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2020, Grupo SBF had an accrual ratio of -0.18. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of R$218m, well over the R$37.0m it reported in profit. Given that Grupo SBF had negative free cash flow in the prior corresponding period, the trailing twelve month resul of R$218m would seem to be a step in the right direction. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Grupo SBF issued 15% more new shares over the last year. As a result, its net income is now split between a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Grupo SBF's EPS by clicking here.

How Is Dilution Impacting Grupo SBF's Earnings Per Share? (EPS)

Grupo SBF's net profit dropped by 87% per year over the last three years. And even focusing only on the last twelve months, we see profit is down 86%. Sadly, earnings per share fell further, down a full 89% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

If Grupo SBF's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

Grupo SBF's profit was reduced by unusual items worth R$225m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. Grupo SBF took a rather significant hit from unusual items in the year to September 2020. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

Our Take On Grupo SBF's Profit Performance

Summing up, Grupo SBF's accrual ratio and its unusual items suggest that its statutory earnings were temporarily depressed (and could bounce back), while the dilution is a negative for shareholders. Looking at all these factors, we'd say that Grupo SBF's underlying earnings power is at least as good as the statutory numbers would make it seem. If you'd like to know more about Grupo SBF as a business, it's important to be aware of any risks it's facing. You'd be interested to know, that we found 3 warning signs for Grupo SBF and you'll want to know about them.

After our examination into the nature of Grupo SBF's profit, we've come away optimistic for the company. 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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