Should You Use O2 Czech Republic’s (SEP:TELEC) 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. This article will consider whether O2 Czech Republic‘s (SEP:TELEC) statutory profits are a good guide to its underlying earnings.

It’s good to see that over the last twelve months O2 Czech Republic made a profit of Kč5.26b on revenue of Kč38.9b. The chart below shows that it has grown revenue over the last three years, while profit has remained roughly flat.

View our latest analysis for O2 Czech Republic

SEP:TELEC Income Statement, January 13th 2020
SEP:TELEC Income Statement, January 13th 2020

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 O2 Czech Republic’s cashflow tells us about the quality of its earnings. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

A Closer Look At O2 Czech Republic’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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2019, O2 Czech Republic recorded an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. To wit, it produced free cash flow of Kč5.3b during the period, falling well short of its reported profit of Kč5.26b. At this point we should mention that O2 Czech Republic did manage to increase its free cash flow in the last twelve months

Our Take On O2 Czech Republic’s Profit Performance

O2 Czech Republic’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 O2 Czech Republic’s statutory profits are better than its underlying earnings power. Sadly, its EPS was down over the last twelve months. 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. Obviously, we love to consider the historical data to inform our opinion of a company. But it can be really valuable to consider what other analysts are forecasting. So feel free to check out our free graph representing analyst forecasts.

This note has only looked at a single factor that sheds light on the nature of O2 Czech Republic’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. 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

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