Is there more to the story than the earnings growth of Silver Lake Resources (ASX: SLR)?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. However, sometimes companies receive a one-time increase (or decrease) in their profits, and it is not always clear whether statutory profits are a good guide for the future. Today we will focus on whether this year’s statutory profits are a good guide to understanding Silver lake resources (ASX: SLR).

While Silver Lake Resources was able to generate A $ 563.4 million in revenue over the past twelve months, we believe its profit result of A $ 256.9 million was larger. Fortunately, he has increased both his profits and his income over the past three years, as you can see in the graph below.

Check out our latest review for Silver Lake Resources

ASX: SLR Earnings and Revenue History February 8, 2021

It’s important to note that statutory profits aren’t always the best tool for understanding a company’s true earnings power, so it’s worth looking at earnings in a bit more detail. So today we’re going to take a look at what Silver Lake Resources’ cash flow tells us about its income, as well as the impact of receiving a tax benefit on its statutory income. This might make you wonder what analysts are predicting in terms of future profitability. Fortunately, you can click here to see an interactive graph depicting future profitability, based on their estimates.

A closer look at the benefits of Silver Lake Resources

A key financial ratio used to measure how well a business converts earnings into free cash flow (FCF) is the accumulation ratio. The accrual ratio subtracts FCF from profit for a given period and divides the profit by the company’s average operating assets over that period. The ratio shows us by how much a company’s profit exceeds its FCF.

This means that a negative accrual ratio is a good thing, because it shows that the company is generating more free cash flow than its profits suggest. This is not to say that we should be worried about a positive accumulation ratio, but it should be noted where the accumulation ratio is rather high. To quote a 2014 article by Lewellen and Resutek, “Firms with higher totals tend to be less profitable in the future.”

Silver Lake Resources has an accrual ratio of 0.25 for the year through June 2020. Unfortunately, that means its free cash flow is significantly lower than its reported profits. In fact, he had A $ 145 million free cash flow last year, which was well below his statutory profit of A $ 256.9 million. At this point, we have to mention that Silver Lake Resources has managed to increase its free cash flow over the past twelve months. It is important to note that an unusual tax situation, which we discuss below, had an impact on the accrual ratio. This would certainly have contributed to the low conversion to cash. One bright spot for Silver Lake Resources shareholders is that its accumulation ratio was significantly better last year, giving reason to believe that it could revert to a stronger cash conversion in the future. Shareholders should seek an improvement in cash flow over current year profit, if this is indeed the case.

An unusual tax situation

Turning from the accrual ratio, it should be noted that Silver Lake Resources benefited from a tax advantage which contributed to the profit of 124 million Australian dollars. This is of course a little unusual, given that it is more common for businesses to pay taxes than to receive tax benefits! Sure, At first glance it’s great to receive a tax benefit. However, our data indicates that tax benefits may temporarily increase statutory profit in the year it is recognized, but profit may then decline. In the probable event that the tax advantage does not recur, we would expect its statutory profit levels to decline, at least in the absence of strong growth. So while we think it’s great to have a tax benefit, it usually involves an increased risk that statutory profit overestimates the company’s sustainable earning capacity.

Our take on Silver Lake Resources earnings performance

Silver Lake Resources’ accumulation ratio indicates low cash flow to earnings, which may be in part due to the tax benefit she received this year. On top of that, the unsustainable nature of the tax benefits means there is a possibility that profits may be lower next year, certainly in the absence of strong growth. For the reasons mentioned above, we believe that a cursory glance at Silver Lake Resources’ statutory earnings might look better than it actually is at an underlying level. If you are interested in learning more about Silver Lake Resources as a business, it is important to be aware of the risks it faces. Be aware that Silver Lake Resources shows 3 warning signs in our investment analysis and 2 of them make us uncomfortable …

Our review of Silver Lake Resources focused on certain factors that may make its profits appear better than they are. And, on that basis, we are somewhat skeptical. But there is always more to be discovered if you are able to focus your mind on the smallest details. For example, many people see a high return on equity as an indication of a favorable business economy, while others like to “follow the money” and look for stocks that insiders are buying. Although it may take a bit of research on your behalf, you can find this free set of companies offering a high return on equity, or that list of stocks that insiders buy to be useful.

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