Here's Why We Think IBI Group's (TSE:IBG) Statutory Earnings Might Be Conservative

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether IBI Group's (TSE:IBG) statutory profits are a good guide to its underlying earnings.

While IBI Group was able to generate revenue of CA$483.6m in the last twelve months, we think its profit result of CA$17.1m was more important. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

Check out our latest analysis for IBI Group

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what IBI Group's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. 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.

A Closer Look At IBI Group's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 September 2020, IBI Group had an accrual ratio of -0.30. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of CA$59m during the period, dwarfing its reported profit of CA$17.1m. IBI Group's free cash flow improved over the last year, which is generally good to see.

Our Take On IBI Group's Profit Performance

As we discussed above, IBI Group's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that IBI Group's statutory profit actually understates its earnings potential! And the EPS is up 10% over the last twelve months. 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. While conducting our analysis, we found that IBI Group has 1 warning sign and it would be unwise to ignore it.

This note has only looked at a single factor that sheds light on the nature of IBI Group'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. 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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