When companies post strong earnings, the stock generally performs well, just like Signet Jewelers Limited's (NYSE:SIG) stock has recently. Our analysis found some more factors that we think are good for shareholders.
A Closer Look At Signet Jewelers' 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. The ratio shows us how much a company's profit exceeds its FCF.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Signet Jewelers has an accrual ratio of -0.86 for the year to May 2021. 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 US$1.5b in the last year, which was a lot more than its statutory profit of US$286.4m. Signet Jewelers shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.
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.
The Impact Of Unusual Items On Profit
Signet Jewelers' profit was reduced by unusual items worth US$59m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. If Signet Jewelers doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.
Our Take On Signet Jewelers' Profit Performance
In conclusion, both Signet Jewelers' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon Signet Jewelers' statutory profit probably understates its earnings potential! 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. When we did our research, we found 2 warning signs for Signet Jewelers (1 is a bit unpleasant!) that we believe deserve your full attention.
After our examination into the nature of Signet Jewelers' profit, we've come away optimistic for the company. 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. 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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