We Think FDM Group (Holdings)'s (LON:FDM) Statutory Profit Might Understate Its Earnings Potential

Broadly speaking, profitable businesses are less risky than unprofitable ones. 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. This article will consider whether FDM Group (Holdings)'s (LON:FDM) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months FDM Group (Holdings) made a profit of UK£37.7m on revenue of UK£277.6m. In the chart below, you can see that its profit and revenue have both grown over the last three years, although its profit has slipped in the last twelve months.

See our latest analysis for FDM Group (Holdings)

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 FDM Group (Holdings)'s cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. 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 FDM Group (Holdings)'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to June 2020, FDM Group (Holdings) had an accrual ratio of -0.39. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of UK£52m during the period, dwarfing its reported profit of UK£37.7m. FDM Group (Holdings)'s free cash flow improved over the last year, which is generally good to see.

Our Take On FDM Group (Holdings)'s Profit Performance

As we discussed above, FDM Group (Holdings)'s accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that FDM Group (Holdings)'s statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 25% 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. So while earnings quality is important, it's equally important to consider the risks facing FDM Group (Holdings) at this point in time. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of FDM Group (Holdings).

Today we've zoomed in on a single data point to better understand the nature of FDM Group (Holdings)'s 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. 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.

When trading FDM Group (Holdings) or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.