Are Colas's (EPA:RE) Statutory Earnings A Good Reflection Of Its Earnings Potential?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Colas (EPA:RE).

We like the fact that Colas made a profit of €68.0m on its revenue of €12.7b, in the last year. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.

Check out our latest analysis for Colas

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 Colas' cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Colas.

Examining Cashflow Against Colas' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

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.

Colas has an accrual ratio of -0.12 for the year to June 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of €541m, well over the €68.0m it reported in profit. Notably, Colas had negative free cash flow last year, so the €541m it produced this year was a welcome improvement.

Our Take On Colas' Profit Performance

As we discussed above, Colas has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Colas' statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. When we did our research, we found 4 warning signs for Colas (1 doesn't sit too well with us!) that we believe deserve your full attention.

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