Statutory Profit Doesn't Reflect How Good Bang & Olufsen's (CPH:BO) Earnings Are

The subdued stock price reaction suggests that Bang & Olufsen a/s' (CPH:BO) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

View our latest analysis for Bang & Olufsen

Examining Cashflow Against Bang & Olufsen'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 August 2021, Bang & Olufsen recorded an accrual ratio of -0.25. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of kr.198m in the last year, which was a lot more than its statutory profit of kr.27.0m. Given that Bang & Olufsen had negative free cash flow in the prior corresponding period, the trailing twelve month resul of kr.198m would seem to be a step in the right direction. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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.

How Do Unusual Items Influence Profit?

Bang & Olufsen's profit was reduced by unusual items worth kr.28m 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 Bang & Olufsen to produce a higher profit next year, all else being equal.

Our Take On Bang & Olufsen's Profit Performance

Considering both Bang & Olufsen's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon Bang & Olufsen's statutory profit probably understates its earnings potential! In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. While conducting our analysis, we found that Bang & Olufsen has 1 warning sign and it would be unwise to ignore this.

Our examination of Bang & Olufsen has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there are plenty of other ways to inform your opinion of a company. 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. 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.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.