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Here's Why We Think Watkin Jones' (LON:WJG) Statutory Earnings Might Be Conservative
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. In this article, we'll look at how useful this year's statutory profit is, when analysing Watkin Jones (LON:WJG).
While Watkin Jones was able to generate revenue of UK£354.1m in the last twelve months, we think its profit result of UK£21.1m was more important. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.
View our latest analysis for Watkin Jones
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 Watkin Jones' cashflow and unusual items tell 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.
Zooming In On Watkin Jones' 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. This ratio tells us how much of a company's profit is not backed by free cashflow.
Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Over the twelve months to September 2020, Watkin Jones recorded an accrual ratio of -0.20. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of UK£38m during the period, dwarfing its reported profit of UK£21.1m. Watkin Jones shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
The Impact Of Unusual Items On Profit
Watkin Jones' profit was reduced by unusual items worth UK£21m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. If Watkin Jones doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.
Our Take On Watkin Jones' Profit Performance
Considering both Watkin Jones' accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon Watkin Jones' statutory profit probably understates its earnings potential! Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. While conducting our analysis, we found that Watkin Jones has 4 warning signs and it would be unwise to ignore these.
Our examination of Watkin Jones has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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About AIM:WJG
Watkin Jones
Engages in the development and the management of properties for residential occupation in the United Kingdom.
Adequate balance sheet and fair value.