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. This article will consider whether Stamps.com's (NASDAQ:STMP) statutory profits are a good guide to its underlying earnings.
While Stamps.com was able to generate revenue of US$712.9m in the last twelve months, we think its profit result of US$152.5m was more important. One positive is that it has grown both its profit and its revenue, over the last few years.
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. So today we'll look at what Stamps.com's cashflow tells us about its earnings, as well as examining how issuing shares is impacting shareholder value. 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.
Zooming In On Stamps.com'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. 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.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
For the year to September 2020, Stamps.com had an accrual ratio of -0.11. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of US$212m in the last year, which was a lot more than its statutory profit of US$152.5m. Over the last year, Stamps.com's free cash flow remained steady. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.
To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Stamps.com expanded the number of shares on issue by 6.8% over the last year. That means its earnings are split among a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Stamps.com's EPS by clicking here.
How Is Dilution Impacting Stamps.com's Earnings Per Share? (EPS)
As you can see above, Stamps.com has been growing its net income over the last few years, with an annualized gain of 9.3% over three years. And at a glance the 88% gain in profit over the last year impresses. But in comparison, EPS only increased by 90% over the same period. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.
In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Stamps.com can grow EPS persistently. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.
Our Take On Stamps.com's Profit Performance
In conclusion, Stamps.com has strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share growth is weaker than its profit growth. Based on these factors, it's hard to tell if Stamps.com's profits are a reasonable reflection of its underlying profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To help with this, we've discovered 3 warning signs (1 is a bit concerning!) that you ought to be aware of before buying any shares in Stamps.com.
In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. 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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