There May Be Reason For Hope In Colefax Group's (LON:CFX) Disappointing Earnings

Shareholders appeared unconcerned with Colefax Group PLC's (LON:CFX) lackluster earnings report last week. We did some digging, and we believe the earnings are stronger than they seem.

View our latest analysis for Colefax Group

Examining Cashflow Against Colefax Group'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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".

Colefax Group has an accrual ratio of -0.38 for the year to October 2023. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of UK£11m in the last year, which was a lot more than its statutory profit of UK£6.01m. Colefax Group did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

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.

Our Take On Colefax Group's Profit Performance

Happily for shareholders, Colefax Group produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Colefax Group's statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 3 warning signs for Colefax Group (of which 1 shouldn't be ignored!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Colefax Group'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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.