Here's Why We Don't Think Sypris Solutions's (NASDAQ:SYPR) Statutory Earnings Reflect Its Underlying Earnings Potential

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. In this article, we'll look at how useful this year's statutory profit is, when analysing Sypris Solutions (NASDAQ:SYPR).

It's good to see that over the last twelve months Sypris Solutions made a profit of US$1.97m on revenue of US$83.4m. The chart below shows that revenue has improved over the last three years, and, even better, the company has moved from unprofitable to profitable.

Check out our latest analysis for Sypris Solutions

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. Therefore, we think it's worth taking a closer look at Sypris Solutions' cashflow, as well as examining the impact that unusual items have had on its reported profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sypris Solutions.

Zooming In On Sypris Solutions' 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). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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.

Over the twelve months to October 2020, Sypris Solutions recorded an accrual ratio of 0.41. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of US$4.2m, in contrast to the aforementioned profit of US$1.97m. We also note that Sypris Solutions' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$4.2m. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. One positive for Sypris Solutions shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Sypris Solutions' profit was boosted by unusual items worth US$758k in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. Sypris Solutions had a rather significant contribution from unusual items relative to its profit to October 2020. 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 Sypris Solutions' Profit Performance

Summing up, Sypris Solutions received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. On reflection, the above-mentioned factors give us the strong impression that Sypris Solutions'underlying earnings power is not as good as it might seem, based on the statutory profit numbers. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To that end, you should learn about the 5 warning signs we've spotted with Sypris Solutions (including 2 which are concerning).

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there are plenty of other ways to inform your opinion of a company. 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. 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.

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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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