Comal S.p.A.'s (BIT:CML) robust recent earnings didn't do much to move the stock. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.
Examining Cashflow Against Comal's Earnings
In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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. 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 2021, Comal had an accrual ratio of 0.70. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of €6.6m, in contrast to the aforementioned profit of €1.26m. We also note that Comal's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of €6.6m.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Comal.
Our Take On Comal's Profit Performance
As we have made quite clear, we're a bit worried that Comal didn't back up the last year's profit with free cashflow. For this reason, we think that Comal's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Comal at this point in time. Our analysis shows 3 warning signs for Comal (2 are concerning!) and we strongly recommend you look at these before investing.
Today we've zoomed in on a single data point to better understand the nature of Comal'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.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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