Investors Shouldn't Be Too Comfortable With Equatorial Pará Distribuidora de Energia's (BVMF:EQPA3) Earnings

Equatorial Pará Distribuidora de Energia S.A. (BVMF:EQPA3) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

Check out our latest analysis for Equatorial Pará Distribuidora de Energia

A Closer Look At Equatorial Pará Distribuidora de Energia's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to December 2023, Equatorial Pará Distribuidora de Energia recorded an accrual ratio of 0.35. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of R$2.23b, a look at free cash flow indicates it actually burnt through R$378m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of R$378m, this year, indicates high risk.

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

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

As we have made quite clear, we're a bit worried that Equatorial Pará Distribuidora de Energia didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Equatorial Pará Distribuidora de Energia's underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that Equatorial Pará Distribuidora de Energia has 3 warning signs (2 shouldn't be ignored!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of Equatorial Pará Distribuidora de Energia's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.