Here's Why We Think NORMA Group's (ETR:NOEJ) Statutory Earnings Might Be Conservative

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding NORMA Group (ETR:NOEJ).

We like the fact that NORMA Group made a profit of €1.83m on its revenue of €956.2m, in the last year. The chart below shows that both revenue and profit have declined over the last three years.

View our latest analysis for NORMA Group

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, today we're going to take a closer look at NORMA Group's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. 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.

Examining Cashflow Against NORMA Group'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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".

For the year to September 2020, NORMA Group had an accrual ratio of -0.11. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of €110m in the last year, which was a lot more than its statutory profit of €1.83m. NORMA Group's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

The Impact Of Unusual Items On Profit

NORMA Group's profit was reduced by unusual items worth €13m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect NORMA Group to produce a higher profit next year, all else being equal.

Our Take On NORMA Group's Profit Performance

In conclusion, both NORMA Group's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think NORMA Group's earnings potential is at least as good as it seems, and maybe even better! So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 3 warning signs for NORMA Group (of which 1 doesn't sit too well with us!) you should know about.

Our examination of NORMA Group has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 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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