Are Feerum's (WSE:FEE) Statutory Earnings A Good Guide To Its Underlying Profitability?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. This article will consider whether Feerum's (WSE:FEE) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Feerum made a profit of zł17.4m on revenue of zł171.2m. In the chart below, you can see that its profit and revenue have both grown over the last three years, although its revenue has slipped in the last twelve months.

View our latest analysis for Feerum

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Today, we'll discuss Feerum's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Feerum.

Examining Cashflow Against Feerum's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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 September 2020, Feerum had an accrual ratio of -0.17. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of zł46m, well over the zł17.4m it reported in profit. Notably, Feerum had negative free cash flow last year, so the zł46m it produced this year was a welcome improvement.

Our Take On Feerum's Profit Performance

As we discussed above, Feerum's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Feerum's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, 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. If you want to do dive deeper into Feerum, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 2 warning signs for Feerum you should know about.

Today we've zoomed in on a single data point to better understand the nature of Feerum'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.

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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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