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 Go-Ahead Group‘s (LON:GOG) statutory profits are a good guide to its underlying earnings.
It’s good to see that over the last twelve months Go-Ahead Group made a profit of UK£58.8m on revenue of UK£3.81b. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.
See our latest analysis for Go-Ahead Group
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. Therefore, we think it’s worth taking a closer look at Go-Ahead Group’s cashflow, as well as examining the impact that unusual items have had on its reported profit. 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.
Examining Cashflow Against Go-Ahead Group’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.
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”.
For the year to June 2019, Go-Ahead Group had an accrual ratio of -0.49. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of UK£127m during the period, dwarfing its reported profit of UK£58.8m. Go-Ahead Group shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.
The Impact Of Unusual Items On Profit
Go-Ahead Group’s profit was reduced by unusual items worth UK£17m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we’d expect to see a strong accrual ratio, which is exactly what has happened in this case. It’s never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that’s hardly a surprise given these line items are considered unusual. If Go-Ahead Group 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 Go-Ahead Group’s Profit Performance
In conclusion, both Go-Ahead Group’s accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Go-Ahead Group’s underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! 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. Luckily, you can check out what analysts are forecsting by clicking here.
After our examination into the nature of Go-Ahead Group’s profit, we’ve come away optimistic for the company. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
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December 25, 2019 at 01:51PM
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We Think Go-Ahead Group’s (LON:GOG) Statutory Profit Might Understate Its Earnings Potential - Simply Wall St
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