C-Com Satellite Systems' (CVE:CMI) Profits Appear To Have Quality Issues

Following the solid earnings report from C-Com Satellite Systems Inc. (CVE:CMI), the market responded by bidding up the stock price. However, we think that shareholders should be cautious as we found some worrying factors underlying the profit.

See our latest analysis for C-Com Satellite Systems

A Closer Look At C-Com Satellite Systems' 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

C-Com Satellite Systems has an accrual ratio of 0.41 for the year to November 2023. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of CA$1.7m, in contrast to the aforementioned profit of CA$1.67m. It's worth noting that C-Com Satellite Systems generated positive FCF of CA$3.1m a year ago, so at least they've done it in the past. The good news for shareholders is that C-Com Satellite Systems' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of C-Com Satellite Systems.

Our Take On C-Com Satellite Systems' Profit Performance

As we discussed above, we think C-Com Satellite Systems' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that C-Com Satellite Systems' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that, its earnings per share increased by 44% in the last year. 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. Every company has risks, and we've spotted 4 warning signs for C-Com Satellite Systems (of which 3 make us uncomfortable!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of C-Com Satellite Systems' 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 that insiders are buying 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.