Is There More To The Story Than Cerillion's (LON:CER) Earnings Growth?

As a general rule, we think profitable companies are less risky than companies that lose money. 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 Cerillion (LON:CER).

It's good to see that over the last twelve months Cerillion made a profit of UK£2.61m on revenue of UK£20.8m. In the chart below, you can see that its profit and revenue have both grown over the last three years.

View our latest analysis for Cerillion

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. Today, we'll discuss Cerillion's free cashflow relative to its earnings, and consider what that tells us about the company. 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 Cerillion'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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. 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 September 2020, Cerillion had an accrual ratio of -0.27. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of UK£5.2m during the period, dwarfing its reported profit of UK£2.61m. Cerillion shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Cerillion's Profit Performance

As we discussed above, Cerillion's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Cerillion's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at 29% per year 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. Ultimately, this article has formed an opinion based on historical data. However, it can also be great to think about what analysts are forecasting for the future. At Simply Wall St, we have analyst estimates which you can view by clicking here.

Today we've zoomed in on a single data point to better understand the nature of Cerillion's profit. 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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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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