We Think That There Are Issues Underlying Afluente Transmissão de Energia Elétrica's (BVMF:AFLT3) Earnings

Afluente Transmissão de Energia Elétrica S.A. (BVMF:AFLT3) announced strong profits, but the stock was stagnant. We did some digging, and we found some concerning factors in the details.

Check out our latest analysis for Afluente Transmissão de Energia Elétrica

A Closer Look At Afluente Transmissão de Energia Elétrica's 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). 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.

Over the twelve months to December 2021, Afluente Transmissão de Energia Elétrica recorded an accrual ratio of 0.38. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. Indeed, in the last twelve months it reported free cash flow of R$26m, which is significantly less than its profit of R$99.8m. At this point we should mention that Afluente Transmissão de Energia Elétrica did manage to increase its free cash flow in the last twelve months The good news for shareholders is that Afluente Transmissão de Energia Elétrica's 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. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Afluente Transmissão de Energia Elétrica.

Our Take On Afluente Transmissão de Energia Elétrica's Profit Performance

As we discussed above, we think Afluente Transmissão de Energia Elétrica's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Afluente Transmissão de Energia Elétrica's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To help with this, we've discovered 2 warning signs (1 is concerning!) that you ought to be aware of before buying any shares in Afluente Transmissão de Energia Elétrica.

Today we've zoomed in on a single data point to better understand the nature of Afluente Transmissão de Energia Elétrica's profit. 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. 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.