We Think That There Are Issues Underlying Instituto de Diagnóstico's (SNSE:INDISA) Earnings

Despite posting some strong earnings, the market for Instituto de Diagnóstico S.A.'s (SNSE:INDISA) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for Instituto de Diagnóstico

Zooming In On Instituto de Diagnóstico'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Instituto de Diagnóstico has an accrual ratio of -0.10 for the year to September 2024. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of CL$22b in the last year, which was a lot more than its statutory profit of CL$1.85b. Instituto de Diagnóstico's free cash flow improved over the last year, which is generally good to see. Importantly, we note an unusual tax situation, which we discuss below, has impacted the accruals ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Instituto de Diagnóstico.

An Unusual Tax Situation

Moving on from the accrual ratio, we note that Instituto de Diagnóstico profited from a tax benefit which contributed CL$2.3b to profit. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! We're sure the company was pleased with its tax benefit. And given that it lost money last year, it seems possible that the benefit is evidence that it now expects to find value in its past tax losses. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth. So while we think it's great to receive a tax benefit, it does tend to imply an increased risk that the statutory profit overstates the sustainable earnings power of the business.

Our Take On Instituto de Diagnóstico's Profit Performance

While Instituto de Diagnóstico's accrual ratio stands testament to its strong cashflow, and indicates good quality earnings, the fact that it received a tax benefit suggests that this year's profit may not be a great guide to its sustainable profit run-rate. Based on these factors, we think it's very unlikely that Instituto de Diagnóstico's statutory profits make it seem much weaker than it is. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. While conducting our analysis, we found that Instituto de Diagnóstico has 2 warning signs and it would be unwise to ignore these.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. 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 with significant insider holdings 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.