We Think PharmaSGP Holding's (ETR:PSG) Statutory Profit Might Understate Its Earnings Potential

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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. In this article, we'll look at how useful this year's statutory profit is, when analysing PharmaSGP Holding (ETR:PSG).

It's good to see that over the last twelve months PharmaSGP Holding made a profit of €16.4m on revenue of €65.4m.

See our latest analysis for PharmaSGP Holding

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. So today we'll look at what PharmaSGP Holding'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.

Examining Cashflow Against PharmaSGP Holding's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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 2020, PharmaSGP Holding recorded an accrual ratio of -0.24. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of €18m during the period, dwarfing its reported profit of €16.4m. PharmaSGP Holding shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On PharmaSGP Holding's Profit Performance

Happily for shareholders, PharmaSGP Holding produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that PharmaSGP Holding's statutory profit actually understates its earnings potential! 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 PharmaSGP Holding, you'd also look into what risks it is currently facing. While conducting our analysis, we found that PharmaSGP Holding has 1 warning sign and it would be unwise to ignore this.

This note has only looked at a single factor that sheds light on the nature of PharmaSGP Holding'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. 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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