Robust Earnings May Not Tell The Whole Story For SRV Yhtiöt Oyj (HEL:SRV1V)

The market shrugged off SRV Yhtiöt Oyj's (HEL:SRV1V) solid earnings report. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

Check out our latest analysis for SRV Yhtiöt Oyj

A Closer Look At SRV Yhtiöt Oyj's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to March 2023, SRV Yhtiöt Oyj had an accrual ratio of 0.31. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Over the last year it actually had negative free cash flow of €3.4m, in contrast to the aforementioned profit of €41.6m. We saw that FCF was €64m a year ago though, so SRV Yhtiöt Oyj has at least been able to generate positive FCF in the past. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares. One positive for SRV Yhtiöt Oyj shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. SRV Yhtiöt Oyj expanded the number of shares on issue by 160% over the last year. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out SRV Yhtiöt Oyj's historical EPS growth by clicking on this link.

A Look At The Impact Of SRV Yhtiöt Oyj's Dilution On Its Earnings Per Share (EPS)

Three years ago, SRV Yhtiöt Oyj lost money. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

If SRV Yhtiöt Oyj's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

The Impact Of Unusual Items On Profit

Unfortunately (in the short term) SRV Yhtiöt Oyj saw its profit reduced by unusual items worth €8.4m. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. 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. In the twelve months to March 2023, SRV Yhtiöt Oyj had a big unusual items expense. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

Our Take On SRV Yhtiöt Oyj's Profit Performance

Summing up, SRV Yhtiöt Oyj's unusual items suggest that its statutory earnings were temporarily depressed, and its accrual ratio indicates a lack of free cash flow relative to profit. On top of that, the dilution means that shareholders now own less of the company. After taking into account all the aforementioned observations we think that SRV Yhtiöt Oyj's profits probably give a generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Our analysis shows 4 warning signs for SRV Yhtiöt Oyj (3 are a bit concerning!) and we strongly recommend you look at them before investing.

Our examination of SRV Yhtiöt Oyj has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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.