Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Atea's (OB:ATEA) statutory profits are a good guide to its underlying earnings.
We like the fact that Atea made a profit of kr524.0m on its revenue of kr38.0b, in the last year. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.
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. As a result, we think it's well worth considering what Atea's cashflow (when compared to its earnings) can tell us about the nature of 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.
Examining Cashflow Against Atea'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. The ratio shows us how much a company's profit exceeds its FCF.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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 September 2020, Atea had an accrual ratio of -0.25. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of kr1.4b in the last year, which was a lot more than its statutory profit of kr524.0m. Atea did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.
Our Take On Atea's Profit Performance
As we discussed above, Atea's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Atea's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. In terms of investment risks, we've identified 2 warning signs with Atea, and understanding these should be part of your investment process.
This note has only looked at a single factor that sheds light on the nature of Atea's profit. 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.
If you decide to trade Atea, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.