Should You Use Empresa Eléctrica Pehuenche's (SNSE:PEHUENCHE) Statutory Earnings To Analyse It?

Statistically speaking, it is less risky to invest in profitable companies than in 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. This article will consider whether Empresa Eléctrica Pehuenche's (SNSE:PEHUENCHE) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Empresa Eléctrica Pehuenche made a profit of CL$82.4b on revenue of CL$153.0b. Happily, it has grown both its profit and revenue over the last three years (but not in the last year), as you can see in the chart below.

View our latest analysis for Empresa Eléctrica Pehuenche

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. As a result, we think it's well worth considering what Empresa Eléctrica Pehuenche'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 Empresa Eléctrica Pehuenche.

Examining Cashflow Against Empresa Eléctrica Pehuenche'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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".

Empresa Eléctrica Pehuenche has an accrual ratio of -0.11 for the year to September 2020. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of CL$97b during the period, dwarfing its reported profit of CL$82.4b. Empresa Eléctrica Pehuenche's year-on-year free cash flow was as flat as two-day-old fizzy drink.

Our Take On Empresa Eléctrica Pehuenche's Profit Performance

As we discussed above, Empresa Eléctrica Pehuenche has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Empresa Eléctrica Pehuenche's statutory profit actually understates its earnings potential! And the EPS is up 16% annually, over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you want to do dive deeper into Empresa Eléctrica Pehuenche, you'd also look into what risks it is currently facing. For instance, we've identified 2 warning signs for Empresa Eléctrica Pehuenche (1 is a bit concerning) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Empresa Eléctrica Pehuenche's profit. 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. 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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