We Don’t Think Staffline Group's (LON:STAF) Earnings Should Make Shareholders Too Comfortable

Staffline Group plc (LON:STAF) posted some decent earnings, but shareholders didn't react strongly. Our analysis suggests they may be concerned about some underlying details.

View our latest analysis for Staffline Group

A Closer Look At Staffline Group's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Staffline Group has an accrual ratio of 0.48 for the year to June 2022. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of UK£1.50m, a look at free cash flow indicates it actually burnt through UK£29m in the last year. We saw that FCF was UK£20m a year ago though, so Staffline Group has at least been able to generate positive FCF in the past. Importantly, we note an unusual tax situation, which we discuss below, has impacted the accruals ratio. This would partially explain why the accrual ratio was so poor. One positive for Staffline Group 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.

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.

An Unusual Tax Situation

Moving on from the accrual ratio, we note that Staffline Group profited from a tax benefit which contributed UK£1.8m to profit. This is meaningful because companies usually pay tax rather than receive tax benefits. We're sure the company was pleased with its tax benefit. And since it previously lost money, it may well simply indicate the realisation of past tax losses. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth. So while we think it's great to receive a tax benefit, it does tend to imply an increased risk that the statutory profit overstates the sustainable earnings power of the business.

Our Take On Staffline Group's Profit Performance

This year, Staffline Group couldn't match its profit with cashflow. If the tax benefit is not repeated, then profit would drop next year, all else being equal. For the reasons mentioned above, we think that a perfunctory glance at Staffline Group's statutory profits might make it look better than it really is on an underlying level. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. When we did our research, we found 2 warning signs for Staffline Group (1 shouldn't be ignored!) 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 is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.