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. This article will consider whether CEI's (SGX:AVV) statutory profits are a good guide to its underlying earnings.
It's good to see that over the last twelve months CEI made a profit of S$7.33m on revenue of S$140.0m. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.
See our latest analysis for CEI
Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. As a result, we think it's well worth considering what CEI's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of CEI.
Examining Cashflow Against CEI'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.
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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
CEI has an accrual ratio of -0.15 for the year to September 2019. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of S$13m in the last year, which was a lot more than its statutory profit of S$7.33m. Notably, CEI had negative free cash flow last year, so the S$13m it produced this year was a welcome improvement.
Our Take On CEI's Profit Performance
As we discussed above, CEI has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that CEI's statutory profit actually understates its earnings potential! And on top of that, its earnings per share increased by 12% in the last year. 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. While earnings are important, another area to consider is the balance sheet. If you're interestedwe have a graphic representation of CEI's balance sheet.
Today we've zoomed in on a single data point to better understand the nature of CEI's profit. 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. 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.
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.