We Think SJR in Scandinavia's (STO:SJR B) Statutory Profit Might Understate Its Earnings Potential

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding SJR in Scandinavia (STO:SJR B).

We like the fact that SJR in Scandinavia made a profit of kr12.3m on its revenue of kr369.4m, in the last year. The chart below shows that revenue has been flat over the last three years, while profit has actually declined.

See our latest analysis for SJR in Scandinavia

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what SJR in Scandinavia's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. 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.

Examining Cashflow Against SJR in Scandinavia'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'.

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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 September 2020, SJR in Scandinavia recorded an accrual ratio of -0.27. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of kr21m in the last year, which was a lot more than its statutory profit of kr12.3m. SJR in Scandinavia's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Our Take On SJR in Scandinavia's Profit Performance

As we discussed above, SJR in Scandinavia's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that SJR in Scandinavia's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. 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. If you'd like to know more about SJR in Scandinavia as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 2 warning signs for SJR in Scandinavia you should be aware of.

This note has only looked at a single factor that sheds light on the nature of SJR in Scandinavia'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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