We Think Seco/Warwick's (WSE:SWG) Statutory Profit Might Understate Its Earnings Potential

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Seco/Warwick's (WSE:SWG) statutory profits are a good guide to its underlying earnings.

While Seco/Warwick was able to generate revenue of zł397.0m in the last twelve months, we think its profit result of zł9.95m was more important. As depicted below, while its revenue may have fallen over the last few years, its profit actually improved.

See our latest analysis for Seco/Warwick

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. So today we'll look at what Seco/Warwick's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Seco/Warwick.

Zooming In On Seco/Warwick'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). 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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, Seco/Warwick had an accrual ratio of -0.24. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of zł60m in the last year, which was a lot more than its statutory profit of zł9.95m. Seco/Warwick shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Seco/Warwick's Profit Performance

Happily for shareholders, Seco/Warwick produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Seco/Warwick'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. 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. 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. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of Seco/Warwick.

This note has only looked at a single factor that sheds light on the nature of Seco/Warwick's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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