Here's Why We Don't Think Jubilee Metals Group's (LON:JLP) Statutory Earnings Reflect Its Underlying Earnings Potential

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 Jubilee Metals Group's (LON:JLP) statutory profits are a good guide to its underlying earnings.

While Jubilee Metals Group was able to generate revenue of UK£54.8m in the last twelve months, we think its profit result of UK£18.3m was more important. The chart below shows that revenue has improved over the last three years, and, even better, the company has moved from unprofitable to profitable.

View our latest analysis for Jubilee Metals Group

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Jubilee Metals Group's cashflow and unusual items tell us about the quality of its earnings, as well as touching on how its recent share issues are impacting shareholders. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Jubilee Metals Group.

Examining Cashflow Against Jubilee Metals 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. 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. 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".

For the year to June 2020, Jubilee Metals Group had an accrual ratio of 0.21. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In fact, it had free cash flow of UK£1.3m in the last year, which was a lot less than its statutory profit of UK£18.3m. Notably, Jubilee Metals Group had negative free cash flow last year, so the UK£1.3m it produced this year was a welcome improvement. Having said that, there is more to consider. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Jubilee Metals Group increased the number of shares on issue by 11% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of Jubilee Metals Group's EPS by clicking here.

A Look At The Impact Of Jubilee Metals Group's Dilution on Its Earnings Per Share (EPS).

Jubilee Metals Group was losing money three years ago. On the bright side, in the last twelve months it grew profit by 161%. But EPS was less impressive, up only 96% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Jubilee Metals Group shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by UK£1.6m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Jubilee Metals Group's Profit Performance

Jubilee Metals Group didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. The dilution means the results are weaker when viewed from a per-share perspective. For the reasons mentioned above, we think that a perfunctory glance at Jubilee Metals Group's statutory profits might make it look better than it really is on an underlying level. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To that end, you should learn about the 3 warning signs we've spotted with Jubilee Metals Group (including 1 which shouldn't be ignored).

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 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. 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. 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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