Should You Use ContextVision's (OB:COV) Statutory Earnings To Analyse It?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 ContextVision (OB:COV).

We like the fact that ContextVision made a profit of kr13.2m on its revenue of kr103.4m, in the last year.

See our latest analysis for ContextVision

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. As a result, today we're going to take a closer look at ContextVision's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Zooming In On ContextVision'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. 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'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2020, ContextVision recorded an accrual ratio of 0.41. 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. In the last twelve months it actually had negative free cash flow, with an outflow of kr29.0k despite its profit of kr13.2m, mentioned above. We also note that ContextVision's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of kr29.0k. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) ContextVision saw its profit reduced by unusual items worth kr10.0m. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect ContextVision to produce a higher profit next year, all else being equal.

Our Take On ContextVision's Profit Performance

ContextVision saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Having considered these factors, we don't think ContextVision's statutory profits give an overly harsh view of the business. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 2 warning signs for ContextVision (of which 1 doesn't sit too well with us!) you should know about.

Our examination of ContextVision has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. 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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