Atom Empreendimentos e Participações' (BVMF:ATOM3) Robust Earnings Are Not All Good News For Shareholders

We didn't see Atom Empreendimentos e Participações S.A.'s (BVMF:ATOM3) stock surge when it reported robust earnings recently. We looked deeper into the numbers and found that shareholders might be concerned with some underlying weaknesses.

View our latest analysis for Atom Empreendimentos e Participações

A Closer Look At Atom Empreendimentos e Participações' 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. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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".

For the year to December 2020, Atom Empreendimentos e Participações had an accrual ratio of 1.73. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. Indeed, in the last twelve months it reported free cash flow of R$3.8m, which is significantly less than its profit of R$12.3m. Atom Empreendimentos e Participações' free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. 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. The good news for shareholders is that Atom Empreendimentos e Participações' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Atom Empreendimentos e Participações.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Atom Empreendimentos e Participações' profit was boosted by unusual items worth R$3.5m 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, after all, that's exactly what the accounting terminology implies. Atom Empreendimentos e Participações had a rather significant contribution from unusual items relative to its profit to December 2020. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Atom Empreendimentos e Participações' Profit Performance

Atom Empreendimentos e Participações 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 Atom Empreendimentos e Participações' statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Atom Empreendimentos e Participações as a business, it's important to be aware of any risks it's facing. For instance, we've identified 3 warning signs for Atom Empreendimentos e Participações (1 is concerning) you should be familiar with.

Our examination of Atom Empreendimentos e Participações 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 are plenty of other ways to inform your opinion of a company. 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. 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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