We’re Not So Sure You Should Rely on Slottsviken Fastighetsaktiebolag’s (NGM:SLOTT B) Statutory Earnings

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company’s underlying profitability. This article will consider whether Slottsviken Fastighetsaktiebolag‘s (NGM:SLOTT B) statutory profits are a good guide to its underlying earnings.

It’s good to see that over the last twelve months Slottsviken Fastighetsaktiebolag made a profit of kr12.0m on revenue of kr7.08m. The chart below shows that while revenue has fallen over the last three years, the company has moved from unprofitable to profitable.

View our latest analysis for Slottsviken Fastighetsaktiebolag

NGM:SLOTT B Income Statement March 27th 2020
NGM:SLOTT B Income Statement March 27th 2020

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. So today we’ll look at what Slottsviken Fastighetsaktiebolag’s cashflow and unusual items tell us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Slottsviken Fastighetsaktiebolag.

Zooming In On Slottsviken Fastighetsaktiebolag’s Earnings

Many investors haven’t heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company’s profit is backed up by free cash flow (FCF) during a given period. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company’s profit is not backed by free cashflow.

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. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Slottsviken Fastighetsaktiebolag has an accrual ratio of 0.30 for the year to September 2019. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. In the last twelve months it actually had negative free cash flow, with an outflow of kr5.0m despite its profit of kr12.0m, mentioned above. We also note that Slottsviken Fastighetsaktiebolag’s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of kr5.0m. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by kr9.8m, in the last year, probably goes some way to explain why its accrual ratio was so weak. 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. And that’s as you’d expect, given these boosts are described as ‘unusual’. Slottsviken Fastighetsaktiebolag had a rather significant contribution from unusual items relative to its profit to September 2019. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Slottsviken Fastighetsaktiebolag’s Profit Performance

Summing up, Slottsviken Fastighetsaktiebolag received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we’d argue Slottsviken Fastighetsaktiebolag’s profits probably give an overly generous impression of its sustainable level of profitability. So if you’d like to dive deeper into this stock, it’s crucial to consider any risks it’s facing. When we did our research, we found 5 warning signs for Slottsviken Fastighetsaktiebolag (4 are significant!) that we believe deserve your full attention.

Our examination of Slottsviken Fastighetsaktiebolag has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.