SPAR Group, Inc.’s (NASDAQ:SGRP) solid earnings report last week was underwhelming to investors. We think that they may be worried about something else, so we did some analysis and found that investors have noticed some soft numbers underlying the profit.
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. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
SPAR Group has an accrual ratio of 0.35 for the year to June 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Even though it reported a profit of US$12.7m, a look at free cash flow indicates it actually burnt through US$1.1m in the last year. It’s worth noting that SPAR Group generated positive FCF of US$3.5m a year ago, so at least they’ve done it in the past. However, that’s not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. The good news for shareholders is that SPAR Group’s accrual ratio was much better last year, so this year’s poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.
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.
How Do Unusual Items Influence Profit?
Given the accrual ratio, it’s not overly surprising that SPAR Group’s profit was boosted by unusual items worth US$11m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it’s very common for unusual items to be once-off in nature. And, after all, that’s exactly what the accounting terminology implies. SPAR Group had a rather significant contribution from unusual items relative to its profit to June 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.
Our Take On SPAR Group’s Profit Performance
Summing up, SPAR Group received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at SPAR Group’s statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into SPAR Group, you’d also look into what risks it is currently facing. For example, SPAR Group has 6 warning signs (and 2 which are significant) we think you should know about.
In this article we’ve looked at a number of factors that can impair the utility of profit numbers, and we’ve come away cautious. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 with significant insider holdings to be useful.
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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.