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. Today we’ll focus on whether this year’s statutory profits are a good guide to understanding Victory Supermarket Chain (TLV:VCTR).
While Victory Supermarket Chain was able to generate revenue of ₪1.71b in the last twelve months, we think its profit result of ₪28.4m was more important. Happily, it has grown both its profit and revenue over the last three years (though we note its profit is down over the last year).
Importantly, statutory profits are not always the best tool for understanding a company’s true earnings power, so it’s well worth examining profits in a little more detail. So today we’ll look at what Victory Supermarket Chain’s cashflow tells us about its earnings, as well as examining how issuing shares is impacting shareholder value. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Victory Supermarket Chain.
Examining Cashflow Against Victory Supermarket Chain’s Earnings
As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company’s free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company’s average operating assets over that period. This ratio tells us how much of a company’s profit is not backed by free cashflow.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 2019, Victory Supermarket Chain had an accrual ratio of -0.12. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. Indeed, in the last twelve months it reported free cash flow of ₪56m, well over the ₪28.4m it reported in profit. Victory Supermarket Chain shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.
One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Victory Supermarket Chain expanded the number of shares on issue by 5.1% over the last year. That means its earnings are split among a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company’s profits, while the net income level gives us a better view of the company’s absolute size. Check out Victory Supermarket Chain’s historical EPS growth by clicking on this link.
A Look At The Impact Of Victory Supermarket Chain’s Dilution on Its Earnings Per Share (EPS).
As you can see above, Victory Supermarket Chain has been growing its net income over the last few years, with an annualized gain of 21% over three years. But EPS was only up 8.1% per year, in the exact same period. Net profit actually dropped by 14% in the last year. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 18%. 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 returnsAnd so, you can see quite clearly that dilution is influencing shareholder earnings.
In the long term, if Victory Supermarket Chain’s earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical “share” of the company’s profit.
Our Take On Victory Supermarket Chain’s Profit Performance
In conclusion, Victory Supermarket Chain has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Given the contrasting considerations, we’re don’t have a strong view as to whether Victory Supermarket Chain’s profits are an apt reflection of its underlying potential for profit. While it’s very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. If you’re interestedwe have a graphic representation of Victory Supermarket Chain’s balance sheet.
In this article we’ve looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.