Stock Analysis

Here's Why Winmark's (NASDAQ:WINA) Statutory Earnings Are Arguably Too Conservative

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NasdaqGM:WINA
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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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Winmark (NASDAQ:WINA).

It's good to see that over the last twelve months Winmark made a profit of US$30.2m on revenue of US$67.1m. Even though its revenue is down over the last three years, its profit has actually increased, as you can see, below.

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NasdaqGM:WINA Earnings and Revenue History January 13th 2021

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what Winmark'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 Winmark.

Examining Cashflow Against Winmark'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2020, Winmark recorded an accrual ratio of -0.70. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of US$40m, well over the US$30.2m it reported in profit. Winmark shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Winmark's Profit Performance

As we discussed above, Winmark's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Winmark's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 44% per year over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. At Simply Wall St, we found 2 warning signs for Winmark and we think they deserve your attention.

This note has only looked at a single factor that sheds light on the nature of Winmark's profit. 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. 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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