Laboratorios Farmaceuticos Rovi (BME:ROVI) Is Growing Earnings But Are They A Good Guide?

As a general rule, we think profitable companies are less risky than companies that lose money. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. In this article, we'll look at how useful this year's statutory profit is, when analysing Laboratorios Farmaceuticos Rovi (BME:ROVI).

While Laboratorios Farmaceuticos Rovi was able to generate revenue of €412.7m in the last twelve months, we think its profit result of €55.4m 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.

See our latest analysis for Laboratorios Farmaceuticos Rovi

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Today, we'll discuss Laboratorios Farmaceuticos Rovi'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.

Examining Cashflow Against Laboratorios Farmaceuticos Rovi'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. 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.

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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Laboratorios Farmaceuticos Rovi has an accrual ratio of 0.27 for the year to September 2020. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of €55.4m, a look at free cash flow indicates it actually burnt through €37m in the last year. We also note that Laboratorios Farmaceuticos Rovi's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of €37m.

Our Take On Laboratorios Farmaceuticos Rovi's Profit Performance

Laboratorios Farmaceuticos Rovi'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. Therefore, it seems possible to us that Laboratorios Farmaceuticos Rovi's true underlying earnings power is actually less than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. 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. 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. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Laboratorios Farmaceuticos Rovi.

This note has only looked at a single factor that sheds light on the nature of Laboratorios Farmaceuticos Rovi'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.

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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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