Vincenzo Zucchi's (BIT:ZUC) Earnings Are Of Questionable Quality

Vincenzo Zucchi S.p.A. (BIT:ZUC) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

See our latest analysis for Vincenzo Zucchi

Examining Cashflow Against Vincenzo Zucchi'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. 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. 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. 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 2020, Vincenzo Zucchi recorded an accrual ratio of 1.18. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of €8.1m during the period, falling well short of its reported profit of €65.4m. Vincenzo Zucchi shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. One positive for Vincenzo Zucchi shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Vincenzo Zucchi.

Our Take On Vincenzo Zucchi's Profit Performance

As we discussed above, we think Vincenzo Zucchi's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Vincenzo Zucchi's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. So while earnings quality is important, it's equally important to consider the risks facing Vincenzo Zucchi at this point in time. Our analysis shows 2 warning signs for Vincenzo Zucchi (1 shouldn't be ignored!) and we strongly recommend you look at them before investing.

This note has only looked at a single factor that sheds light on the nature of Vincenzo Zucchi'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. 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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