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. Today we'll focus on whether this year's statutory profits are a good guide to understanding S.A.I. Leisure Group (HKG:1832).
We like the fact that S.A.I. Leisure Group made a profit of US$10.1m on its revenue of US$98.7m, in the last year. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.
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. Today, we'll discuss S.A.I. Leisure Group's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of S.A.I. Leisure Group.
Examining Cashflow Against S.A.I. Leisure Group'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. 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 December 2019, S.A.I. Leisure Group recorded an accrual ratio of -0.13. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of US$17m during the period, dwarfing its reported profit of US$10.1m. Notably, S.A.I. Leisure Group had negative free cash flow last year, so the US$17m it produced this year was a welcome improvement.
Our Take On S.A.I. Leisure Group's Profit Performance
As we discussed above, S.A.I. Leisure Group has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that S.A.I. Leisure Group's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. 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 want to do dive deeper into S.A.I. Leisure Group, you'd also look into what risks it is currently facing. For example, we've found that S.A.I. Leisure Group has 3 warning signs (1 doesn't sit too well with us!) that deserve your attention before going any further with your analysis.
This note has only looked at a single factor that sheds light on the nature of S.A.I. Leisure Group's profit. But there are plenty of other ways to inform your opinion of a company. 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. 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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