Here's Why We Don't Think Grenobloise d'Electronique et d'Automatismes Société Anonyme's (EPA:GEA) Statutory Earnings Reflect Its Underlying Earnings Potential

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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 Grenobloise d'Electronique et d'Automatismes Société Anonyme (EPA:GEA).

It's good to see that over the last twelve months Grenobloise d'Electronique et d'Automatismes Société Anonyme made a profit of €3.45m on revenue of €39.8m. In the last few years both its revenue and its profit have fallen, as you can see in the chart below.

View our latest analysis for Grenobloise d'Electronique et d'Automatismes Société Anonyme

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. Today, we'll discuss Grenobloise d'Electronique et d'Automatismes Société Anonyme's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Grenobloise d'Electronique et d'Automatismes Société Anonyme.

Examining Cashflow Against Grenobloise d'Electronique et d'Automatismes Société Anonyme'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). 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. The ratio shows us how much a company's profit exceeds its FCF.

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

For the year to March 2020, Grenobloise d'Electronique et d'Automatismes Société Anonyme had an accrual ratio of 0.40. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. Indeed, in the last twelve months it reported free cash flow of €559k, which is significantly less than its profit of €3.45m. Given that Grenobloise d'Electronique et d'Automatismes Société Anonyme had negative free cash flow in the prior corresponding period, the trailing twelve month resul of €559k would seem to be a step in the right direction.

Our Take On Grenobloise d'Electronique et d'Automatismes Société Anonyme's Profit Performance

As we discussed above, we think Grenobloise d'Electronique et d'Automatismes Société Anonyme's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Grenobloise d'Electronique et d'Automatismes Société Anonyme's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over the last twelve months. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you want to do dive deeper into Grenobloise d'Electronique et d'Automatismes Société Anonyme, you'd also look into what risks it is currently facing. Our analysis shows 4 warning signs for Grenobloise d'Electronique et d'Automatismes Société Anonyme (2 are a bit unpleasant!) and we strongly recommend you look at these before investing.

This note has only looked at a single factor that sheds light on the nature of Grenobloise d'Electronique et d'Automatismes Société Anonyme's profit. 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.

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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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