Is There More To The Story Than Sheng Siong Group's (SGX:OV8) Earnings Growth?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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 Sheng Siong Group (SGX:OV8).

While Sheng Siong Group was able to generate revenue of S$1.32b in the last twelve months, we think its profit result of S$124.0m was more important. One positive is that it has grown both its profit and its revenue, over the last few years.

See our latest analysis for Sheng Siong Group

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. So today we'll look at what Sheng Siong Group's cashflow tells us about the quality of its earnings. 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 Sheng Siong Group'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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Sheng Siong Group has an accrual ratio of -0.43 for the year to September 2020. 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 S$206m during the period, dwarfing its reported profit of S$124.0m. Sheng Siong Group shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Sheng Siong Group's Profit Performance

Happily for shareholders, Sheng Siong Group produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Sheng Siong Group's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Better yet, its EPS are growing strongly, which is nice to see. 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 want to do dive deeper into Sheng Siong Group, you'd also look into what risks it is currently facing. When we did our research, we found 2 warning signs for Sheng Siong Group (1 is a bit unpleasant!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Sheng Siong Group's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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. 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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