Embpar Participacoes' (BVMF:EPAR3) Conservative Accounting Might Explain Soft Earnings

Embpar Participacoes S.A.'s (BVMF:EPAR3) earnings announcement last week didn't impress shareholders. While the headline numbers were soft, we believe that investors might be missing some encouraging factors.

View our latest analysis for Embpar Participacoes

Zooming In On Embpar Participacoes' 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2024, Embpar Participacoes had an accrual ratio of -0.43. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of R$43m in the last year, which was a lot more than its statutory profit of R$7.69m. Given that Embpar Participacoes had negative free cash flow in the prior corresponding period, the trailing twelve month resul of R$43m would seem to be a step in the right direction. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Embpar Participacoes.

How Do Unusual Items Influence Profit?

Embpar Participacoes' profit was reduced by unusual items worth R$1.4m 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. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. If Embpar Participacoes doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Embpar Participacoes' Profit Performance

In conclusion, both Embpar Participacoes' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon Embpar Participacoes' statutory profit probably understates its earnings potential! If you want to do dive deeper into Embpar Participacoes, you'd also look into what risks it is currently facing. To help with this, we've discovered 3 warning signs (1 is a bit concerning!) that you ought to be aware of before buying any shares in Embpar Participacoes.

Our examination of Embpar Participacoes has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 with significant insider holdings 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.