Equatorial Maranhão Distribuidora de Energia's (BVMF:EQMA3B) Profits May Not Reveal Underlying Issues

Equatorial Maranhão Distribuidora de Energia S.A.'s (BVMF:EQMA3B) robust recent earnings didn't do much to move the stock. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for Equatorial Maranhão Distribuidora de Energia

Examining Cashflow Against Equatorial Maranhão Distribuidora de Energia'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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

Equatorial Maranhão Distribuidora de Energia has an accrual ratio of 0.21 for the year to December 2023. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of R$378m, in contrast to the aforementioned profit of R$777.4m. We saw that FCF was R$229m a year ago though, so Equatorial Maranhão Distribuidora de Energia has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Equatorial Maranhão Distribuidora de Energia.

Our Take On Equatorial Maranhão Distribuidora de Energia's Profit Performance

Equatorial Maranhão Distribuidora de Energia's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Equatorial Maranhão Distribuidora de Energia's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 11% per annum growth in EPS for the last three. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, Equatorial Maranhão Distribuidora de Energia has 3 warning signs (and 2 which are a bit concerning) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Equatorial Maranhão Distribuidora de Energia's profit. 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.