Companhia de Saneamento Básico do Estado de São Paulo - SABESP's (BVMF:SBSP3) Promising Earnings May Rest On Soft Foundations

Companhia de Saneamento Básico do Estado de São Paulo - SABESP (BVMF:SBSP3) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

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Examining Cashflow Against Companhia de Saneamento Básico do Estado de São Paulo - SABESP'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. 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".

Companhia de Saneamento Básico do Estado de São Paulo - SABESP has an accrual ratio of 0.20 for the year to December 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of R$626m, in contrast to the aforementioned profit of R$9.58b. We saw that FCF was R$716m a year ago though, so Companhia de Saneamento Básico do Estado de São Paulo - SABESP has at least been able to generate positive FCF in the past.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Companhia de Saneamento Básico do Estado de São Paulo - SABESP's Profit Performance

Companhia de Saneamento Básico do Estado de São Paulo - SABESP didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Companhia de Saneamento Básico do Estado de São Paulo - SABESP's true underlying earnings power is actually less than its statutory profit. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, Companhia de Saneamento Básico do Estado de São Paulo - SABESP has 4 warning signs (and 2 which are a bit unpleasant) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Companhia de Saneamento Básico do Estado de São Paulo - SABESP'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. 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.