Gem Diamonds' (LON:GEMD) Performance Is Even Better Than Its Earnings Suggest

When companies post strong earnings, the stock generally performs well, just like Gem Diamonds Limited's (LON:GEMD) stock has recently. Our analysis found some more factors that we think are good for shareholders.

View our latest analysis for Gem Diamonds

Zooming In On Gem Diamonds' 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. 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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Gem Diamonds has an accrual ratio of -0.13 for the year to December 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of US$47m in the last year, which was a lot more than its statutory profit of US$16.9m. Notably, Gem Diamonds had negative free cash flow last year, so the US$47m it produced this year was a welcome improvement.

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 Gem Diamonds' Profit Performance

As we discussed above, Gem Diamonds has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Gem Diamonds' statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Gem Diamonds, you'd also look into what risks it is currently facing. When we did our research, we found 3 warning signs for Gem Diamonds (1 is a bit unpleasant!) that we believe deserve your full attention.

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