Statutory Profit Doesn't Reflect How Good Cedergrenska's (STO:CEDER) Earnings Are

Even though Cedergrenska AB (publ)'s (STO:CEDER) recent earnings release was robust, the market didn't seem to notice. Investors are probably missing some underlying factors which are encouraging for the future of the company.

View our latest analysis for Cedergrenska

A Closer Look At Cedergrenska'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 December 2024, Cedergrenska had an accrual ratio of -0.41. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of kr75m during the period, dwarfing its reported profit of kr13.5m. Cedergrenska shareholders are no doubt pleased that free cash flow improved over the last twelve months. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Cedergrenska.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Cedergrenska increased the number of shares on issue by 21% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Cedergrenska's EPS by clicking here.

A Look At The Impact Of Cedergrenska's Dilution On Its Earnings Per Share (EPS)

Unfortunately, we don't have any visibility into its profits three years back, because we lack the data. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). Therefore, the dilution is having a noteworthy influence on shareholder returns.

If Cedergrenska's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Cedergrenska's Profit Performance

In conclusion, Cedergrenska has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Based on these factors, we think that Cedergrenska's profits are a reasonably conservative guide to its underlying profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For instance, we've identified 3 warning signs for Cedergrenska (1 makes us a bit uncomfortable) you should be familiar with.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.