HORNBACH Holding KGaA's (ETR:HBH) Earnings Are Growing But Is There More To The Story?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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 HORNBACH Holding KGaA (ETR:HBH).

While HORNBACH Holding KGaA was able to generate revenue of €5.49b in the last twelve months, we think its profit result of €196.1m was more important. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

View our latest analysis for HORNBACH Holding KGaA

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. Today, we'll discuss HORNBACH Holding KGaA's free cashflow relative to its earnings, and consider what that tells us about the company. 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.

Zooming In On HORNBACH Holding KGaA'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to November 2020, HORNBACH Holding KGaA recorded an accrual ratio of -0.12. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of €426m during the period, dwarfing its reported profit of €196.1m. HORNBACH Holding KGaA's free cash flow improved over the last year, which is generally good to see.

Our Take On HORNBACH Holding KGaA's Profit Performance

HORNBACH Holding KGaA's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think HORNBACH Holding KGaA's earnings potential is at least as good as it seems, and maybe even better! Better yet, its EPS are growing strongly, which is nice to see. 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. So while earnings quality is important, it's equally important to consider the risks facing HORNBACH Holding KGaA at this point in time. To that end, you should learn about the 2 warning signs we've spotted with HORNBACH Holding KGaA (including 1 which is significant).

This note has only looked at a single factor that sheds light on the nature of HORNBACH Holding KGaA's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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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