Stock Analysis

We Think PageGroup's (LON:PAGE) Statutory Profit Might Understate Its Earnings Potential

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LSE:PAGE
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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. This article will consider whether PageGroup's (LON:PAGE) statutory profits are a good guide to its underlying earnings.

We like the fact that PageGroup made a profit of UK£47.8m on its revenue of UK£1.49b, in the last year. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

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earnings-and-revenue-history
LSE:PAGE Earnings and Revenue History December 10th 2020

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. Today, we'll discuss PageGroup's free cashflow relative to its earnings, and consider what that tells us about the company. 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.

A Closer Look At PageGroup's 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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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 June 2020, PageGroup had an accrual ratio of -0.58. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of UK£176m, well over the UK£47.8m it reported in profit. PageGroup shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On PageGroup's Profit Performance

Happily for shareholders, PageGroup produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that PageGroup's 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. So while earnings quality is important, it's equally important to consider the risks facing PageGroup at this point in time. For example - PageGroup has 1 warning sign we think you should be aware of.

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