We Think That There Are More Issues For 4C Group (STO:4C) Than Just Sluggish Earnings

Investors were disappointed by 4C Group AB (publ)'s (STO:4C ) latest earnings release. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.

Check out our latest analysis for 4C Group

Examining Cashflow Against 4C Group's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

4C Group has an accrual ratio of 0.33 for the year to December 2022. 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. Even though it reported a profit of kr26.3m, a look at free cash flow indicates it actually burnt through kr4.0m in the last year. We saw that FCF was kr55m a year ago though, so 4C Group has at least been able to generate positive FCF in the past. The good news for shareholders is that 4C Group's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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 4C Group's Profit Performance

As we have made quite clear, we're a bit worried that 4C Group didn't back up the last year's profit with free cashflow. For this reason, we think that 4C Group's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing 4C Group at this point in time. Our analysis shows 2 warning signs for 4C Group (1 is potentially serious!) and we strongly recommend you look at these before investing.

This note has only looked at a single factor that sheds light on the nature of 4C Group'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. 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. 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.