Should You Use Swiss Water Decaffeinated Coffee's (TSE:SWP) Statutory Earnings To Analyse It?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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 Swiss Water Decaffeinated Coffee (TSE:SWP).

We like the fact that Swiss Water Decaffeinated Coffee made a profit of CA$3.99m on its revenue of CA$98.1m, in the last year. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

View our latest analysis for Swiss Water Decaffeinated Coffee

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 Swiss Water Decaffeinated Coffee's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Swiss Water Decaffeinated Coffee.

A Closer Look At Swiss Water Decaffeinated Coffee'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2020, Swiss Water Decaffeinated Coffee had an accrual ratio of 0.22. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of CA$14m despite its profit of CA$3.99m, mentioned above. We also note that Swiss Water Decaffeinated Coffee's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CA$14m.

Our Take On Swiss Water Decaffeinated Coffee's Profit Performance

Swiss Water Decaffeinated Coffee's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Swiss Water Decaffeinated Coffee's statutory profits are better than its underlying earnings power. The good news is that, its earnings per share increased by 27% in the last year. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 3 warning signs for Swiss Water Decaffeinated Coffee (2 are concerning!) and we strongly recommend you look at them before investing.

Today we've zoomed in on a single data point to better understand the nature of Swiss Water Decaffeinated Coffee's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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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