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 i2 Development (WSE:I2D).
We like the fact that i2 Development made a profit of zł9.03m on its revenue of zł227.1m, in the last year. The chart below shows that revenue has improved over the last three years, and, even better, the company has moved from unprofitable to profitable.
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 i2 Development’s cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of i2 Development.
A Closer Look At i2 Development’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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company’s average operating assets over that period. You could think of the accrual ratio from cashflow as the ‘non-FCF profit ratio’.
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”.
Over the twelve months to June 2020, i2 Development recorded an accrual ratio of -0.14. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of zł66m during the period, dwarfing its reported profit of zł9.03m. Notably, i2 Development had negative free cash flow last year, so the zł66m it produced this year was a welcome improvement. However, that’s not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
The Impact Of Unusual Items On Profit
While the accrual ratio might bode well, we also note that i2 Development’s profit was boosted by unusual items worth zł2.7m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. Assuming those unusual items don’t show up again in the current year, we’d thus expect profit to be weaker next year (in the absence of business growth, that is).
Our Take On i2 Development’s Profit Performance
In conclusion, i2 Development’s accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering the aforementioned, we think that i2 Development’s profits are probably a reasonable reflection of its underlying profitability; although we’d be confident in that conclusion if we saw a cleaner set of results. If you’d like to know more about i2 Development as a business, it’s important to be aware of any risks it’s facing. In terms of investment risks, we’ve identified 5 warning signs with i2 Development, and understanding them should be part of your investment process.
Our examination of i2 Development 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. 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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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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