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Dundee Corporation (TSE:DC.A) posted some decent earnings, but shareholders didn't react strongly. We think that they might be concerned about some underlying details that our analysis found.
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A Closer Look At Dundee'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
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".
Over the twelve months to September 2024, Dundee recorded an accrual ratio of 0.29. 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. Over the last year it actually had negative free cash flow of CA$12m, in contrast to the aforementioned profit of CA$65.5m. We also note that Dundee's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CA$12m. 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.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Dundee.
How Do Unusual Items Influence Profit?
The fact that the company had unusual items boosting profit by CA$81m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. We can see that Dundee's positive unusual items were quite significant relative to its profit in the year to September 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.