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M&C Saatchi plc's (LON:SAA) solid earnings announcement recently didn't do much to the stock price. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.
Examining Cashflow Against M&C Saatchi'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.
Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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".
M&C Saatchi has an accrual ratio of -0.19 for the year to December 2024. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of UK£16m during the period, dwarfing its reported profit of UK£11.7m. Notably, M&C Saatchi had negative free cash flow last year, so the UK£16m it produced this year was a welcome improvement. 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.
View our latest analysis for M&C Saatchi
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?
M&C Saatchi's profit was reduced by unusual items worth UK£12m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. 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 M&C Saatchi doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.