Impressive Earnings May Not Tell The Whole Story For Scandinavian Enviro Systems (STO:SES)

Investors were disappointed with Scandinavian Enviro Systems AB (publ)'s (STO:SES) earnings, despite the strong profit numbers. We think that the market might be paying attention to some underlying factors that they find to be concerning.

View our latest analysis for Scandinavian Enviro Systems

Zooming In On Scandinavian Enviro Systems' 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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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".

Over the twelve months to December 2024, Scandinavian Enviro Systems recorded an accrual ratio of 0.38. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of kr53.6m, a look at free cash flow indicates it actually burnt through kr30m in the last year. We also note that Scandinavian Enviro Systems' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of kr30m.

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 Scandinavian Enviro Systems' Profit Performance

As we have made quite clear, we're a bit worried that Scandinavian Enviro Systems didn't back up the last year's profit with free cashflow. For this reason, we think that Scandinavian Enviro Systems' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Case in point: We've spotted 2 warning signs for Scandinavian Enviro Systems you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Scandinavian Enviro Systems' 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 with significant insider holdings to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.