As a general rule, we think profitable companies are less risky than companies that lose money. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether MeVis Medical Solutions’ (ETR:M3V) statutory profits are a good guide to its underlying earnings.
While MeVis Medical Solutions was able to generate revenue of €17.1m in the last twelve months, we think its profit result of €5.70m was more important. As depicted below, while its revenue may have fallen over the last few years, its profit actually improved.
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 MeVis Medical Solutions’ 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 MeVis Medical Solutions.
Examining Cashflow Against MeVis Medical Solutions’ Earnings
As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company’s free cash flow (FCF) matches its profit. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Over the twelve months to September 2020, MeVis Medical Solutions recorded an accrual ratio of 0.20. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In fact, it had free cash flow of €2.8m in the last year, which was a lot less than its statutory profit of €5.70m. MeVis Medical Solutions’ free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits.
Our Take On MeVis Medical Solutions’ Profit Performance
MeVis Medical Solutions didn’t convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that MeVis Medical Solutions’ true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in the last year. 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. With this in mind, we wouldn’t consider investing in a stock unless we had a thorough understanding of the risks. To that end, you should learn about the 2 warning signs we’ve spotted with MeVis Medical Solutions (including 1 which makes us a bit uncomfortable).
Today we’ve zoomed in on a single data point to better understand the nature of MeVis Medical Solutions’ profit. 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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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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