Should You Rely On Corby Spirit and Wine's (TSE:CSW.A) Earnings Growth?

Broadly speaking, profitable businesses are less risky than unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding Corby Spirit and Wine (TSE:CSW.A).

It's good to see that over the last twelve months Corby Spirit and Wine made a profit of CA$31.0m on revenue of CA$158.1m. In the chart below, you can see that its profit and revenue have both grown over the last three years.

See our latest analysis for Corby Spirit and Wine

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Corby Spirit and Wine's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Corby Spirit and Wine.

Zooming In On Corby Spirit and Wine'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. 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. 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, Corby Spirit and Wine had an accrual ratio of -0.13. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of CA$45m, well over the CA$31.0m it reported in profit. Corby Spirit and Wine's free cash flow improved over the last year, which is generally good to see.

Our Take On Corby Spirit and Wine's Profit Performance

As we discussed above, Corby Spirit and Wine has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Corby Spirit and Wine's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 24% per year over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. In terms of investment risks, we've identified 1 warning sign with Corby Spirit and Wine, and understanding this should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Corby Spirit and Wine's profit. 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. 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 that insiders are buying to be useful.

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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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