SDI Group's (LON:SDI) Earnings Are Growing But Is There More To The Story?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. This article will consider whether SDI Group's (LON:SDI) statutory profits are a good guide to its underlying earnings.

While SDI Group was able to generate revenue of UK£27.2m in the last twelve months, we think its profit result of UK£3.24m was more important. One positive is that it has grown both its profit and its revenue, over the last few years.

See our latest analysis for SDI Group

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. So today we'll look at what SDI Group's cashflow tells us about the quality of its earnings. 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.

Examining Cashflow Against SDI 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. 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.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

SDI Group has an accrual ratio of -0.12 for the year to October 2020. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of UK£5.7m during the period, dwarfing its reported profit of UK£3.24m. SDI Group's free cash flow improved over the last year, which is generally good to see.

Our Take On SDI Group's Profit Performance

SDI Group's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think SDI Group's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. 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'd like to know more about SDI Group as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 1 warning sign for SDI Group you should be aware of.

This note has only looked at a single factor that sheds light on the nature of SDI Group's profit. 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.

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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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