Mercator Medical S.A.'s (WSE:MRC) robust earnings report didn't manage to move the market for its stock. We did some digging, and we found some concerning factors in the details.
Examining Cashflow Against Mercator Medical'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. 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. 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 2021, Mercator Medical recorded an accrual ratio of 0.79. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. Indeed, in the last twelve months it reported free cash flow of zł828m, which is significantly less than its profit of zł1.20b. At this point we should mention that Mercator Medical did manage to increase its free cash flow in the last twelve months
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.
Our Take On Mercator Medical's Profit Performance
As we have made quite clear, we're a bit worried that Mercator Medical didn't back up the last year's profit with free cashflow. For this reason, we think that Mercator Medical's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Mercator Medical at this point in time. To help with this, we've discovered 3 warning signs (2 are a bit unpleasant!) that you ought to be aware of before buying any shares in Mercator Medical.
This note has only looked at a single factor that sheds light on the nature of Mercator Medical'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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
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