Should You Use Strix Group's (LON:KETL) Statutory Earnings To Analyse It?

Broadly speaking, profitable businesses are less risky than unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Strix Group (LON:KETL).

It's good to see that over the last twelve months Strix Group made a profit of UK£22.0m on revenue of UK£87.7m. In the last few years both its revenue and its profit have fallen, as you can see in the chart below.

View our latest analysis for Strix Group

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. Therefore, today we'll take a look at Strix Group's cashflow, share issues and unusual items with a view to better understanding the nature of its statutory 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.

A Closer Look At Strix Group's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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.

Over the twelve months to June 2020, Strix Group recorded an accrual ratio of 0.24. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Indeed, in the last twelve months it reported free cash flow of UK£15m, which is significantly less than its profit of UK£22.0m. Strix Group's free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. However, that's not the end of the story. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Strix Group issued 8.4% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of Strix Group's EPS by clicking here.

A Look At The Impact Of Strix Group's Dilution on Its Earnings Per Share (EPS).

Strix Group's net profit dropped by 4.5% per year over the last three years. But over the last year profit has held pretty steady. But EPS was considerably worse, since it declined 7.1% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if Strix Group's earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

The Impact Of Unusual Items On Profit

Strix Group's profit suffered from unusual items, which reduced profit by UK£5.8m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If Strix Group 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 Strix Group's Profit Performance

Summing up, Strix Group's unusual items suggest that its statutory earnings were temporarily depressed, and its accrual ratio indicates a lack of free cash flow relative to profit. On top of that, the dilution means that shareholders now own less of the company. Based on these factors, we think that Strix Group's statutory profits probably make it seem better than it is on an underlying level. If you'd like to know more about Strix Group as a business, it's important to be aware of any risks it's facing. Our analysis shows 5 warning signs for Strix Group (1 is a bit unpleasant!) and we strongly recommend you look at these bad boys before investing.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.

If you’re looking to trade Strix Group, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade 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.