Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Macro Enterprises (CVE:MCR).
It's good to see that over the last twelve months Macro Enterprises made a profit of CA$9.66m on revenue of CA$264.6m. The good news is that the company managed to grow its revenue over the last three years, and also move from loss-making to profitable.
Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. So today we'll look at what Macro Enterprises' cashflow and unusual items tell us about the quality of its earnings. 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 Macro Enterprises' Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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, Macro Enterprises had an accrual ratio of 0.35. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of CA$29m, in contrast to the aforementioned profit of CA$9.66m. It's worth noting that Macro Enterprises generated positive FCF of CA$6.5m a year ago, so at least they've done it in the past. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
The Impact Of Unusual Items On Profit
The fact that the company had unusual items boosting profit by CA$2.3m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).
Our Take On Macro Enterprises' Profit Performance
Macro Enterprises had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Macro Enterprises' profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To that end, you should learn about the 3 warning signs we've spotted with Macro Enterprises (including 1 which is a bit unpleasant).
Our examination of Macro Enterprises has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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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