As a general rule, we think profitable companies are less risky than companies that lose money. 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. In this article, we'll look at how useful this year's statutory profit is, when analysing Foncière Volta (EPA:SPEL).
While Foncière Volta was able to generate revenue of €110.6m in the last twelve months, we think its profit result of €17.9m was more important. Happily, it has grown both its profit and revenue over the last three years (though we note its profit is down over the last year).
Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, today we're going to take a closer look at Foncière Volta's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Foncière Volta.
Examining Cashflow Against Foncière Volta'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
For the year to June 2020, Foncière Volta 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. In the last twelve months it actually had negative free cash flow, with an outflow of €28m despite its profit of €17.9m, mentioned above. We saw that FCF was €101m a year ago though, so Foncière Volta has at least been able to generate positive FCF in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. One positive for Foncière Volta 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. As a result, some shareholders may be looking for stronger cash conversion in the current year.
How Do Unusual Items Influence Profit?
On top of the noteworthy accrual ratio and the spike in non-operating revenue, we can also see that Foncière Volta benefitted from unusual items worth €7.9m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Foncière Volta's positive unusual items were quite significant relative to its profit in the year to June 2020. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.
Our Take On Foncière Volta's Profit Performance
Foncière Volta had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Foncière Volta's statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Foncière Volta at this point in time. When we did our research, we found 4 warning signs for Foncière Volta (2 are a bit concerning!) that we believe deserve your full attention.
In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.
If you’re looking to trade Foncière Volta, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.