Dis-Chem Pharmacies' (JSE:DCP) Strong Earnings Are Of Good Quality

Dis-Chem Pharmacies Limited (JSE:DCP) recently posted some strong earnings, and the market responded positively. We have done some analysis, and we found several positive factors beyond the profit numbers.

See our latest analysis for Dis-Chem Pharmacies

Examining Cashflow Against Dis-Chem Pharmacies' 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). 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to August 2021, Dis-Chem Pharmacies recorded an accrual ratio of -0.32. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of R1.8b, well over the R775.8m it reported in profit. Dis-Chem Pharmacies' free cash flow improved over the last year, which is generally good to see.

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.

Our Take On Dis-Chem Pharmacies' Profit Performance

As we discussed above, Dis-Chem Pharmacies' 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 Dis-Chem Pharmacies' statutory profit actually understates its earnings potential! And the EPS is up 8.1% annually, over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. Ultimately, this article has formed an opinion based on historical data. However, it can also be great to think about what analysts are forecasting for the future. So feel free to check out our free graph representing analyst forecasts.

Today we've zoomed in on a single data point to better understand the nature of Dis-Chem Pharmacies' 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. 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.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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