G.M. Leather's (BIT:GML) Problems Go Beyond Weak Profit

G.M. Leather S.p.A.'s (BIT:GML) recent weak earnings report didn't cause a big stock movement. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for G.M. Leather

A Closer Look At G.M. Leather'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 December 2022, G.M. Leather had an accrual ratio of 0.27. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of €4.6m despite its profit of €2.01m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of €4.6m, this year, indicates high risk.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of G.M. Leather.

Our Take On G.M. Leather's Profit Performance

G.M. Leather didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that G.M. Leather's true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in the last year. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To that end, you should learn about the 4 warning signs we've spotted with G.M. Leather (including 3 which shouldn't be ignored).

This note has only looked at a single factor that sheds light on the nature of G.M. Leather's profit. 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. 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.

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

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.