Here's Why Sopheon's (LON:SPE) Statutory Earnings Are Arguably Too Conservative

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Sopheon's (LON:SPE) statutory profits are a good guide to its underlying earnings.

While Sopheon was able to generate revenue of US$30.4m in the last twelve months, we think its profit result of US$1.74m was more important. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

Check out our latest analysis for Sopheon

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. As a result, we think it's well worth considering what Sopheon's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sopheon.

A Closer Look At Sopheon'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 June 2020, Sopheon had an accrual ratio of -0.40. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of US$4.4m, well over the US$1.74m it reported in profit. Sopheon's free cash flow improved over the last year, which is generally good to see.

Our Take On Sopheon's Profit Performance

Happily for shareholders, Sopheon produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Sopheon's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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 Sopheon as a business, it's important to be aware of any risks it's facing. While conducting our analysis, we found that Sopheon has 1 warning sign and it would be unwise to ignore it.

Today we've zoomed in on a single data point to better understand the nature of Sopheon's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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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