Statistically speaking it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company’s underlying profitability. This article will consider whether Expedia Group‘s (NASDAQ:EXPE) statutory profits are a good guide to its underlying earnings.
We like the fact that Expedia Group made a profit of US$506.0m on its revenue of US$11.9b, in the last year. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.
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. So today we’ll look at what Expedia Group’s cashflow and unusual items tell us about the quality of its earnings. 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.
Examining Cashflow Against Expedia Group’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. 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”.
Expedia Group has an accrual ratio of -0.11 for the year to September 2019. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of US$1.2b in the last year, which was a lot more than its statutory profit of US$506.0m. Expedia Group’s free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.
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.
How Do Unusual Items Influence Profit?
Expedia Group’s profit was reduced by unusual items worth US$147m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we’d expect to see a strong accrual ratio, which is exactly what has happened in this case. 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. Assuming those unusual expenses don’t come up again, we’d therefore expect Expedia Group to produce a higher profit next year, all else being equal.
Our Take On Expedia Group’s Profit Performance
Considering both Expedia Group’s accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company’s underlying earnings power. Looking at all these factors, we’d say that Expedia Group’s underlying earnings power is at least as good as the statutory numbers would make it seem. Ultimately, this article has formed an opinion based on historical data. However, it can also be great to think about what analysts are forecasting for the future. So feel free to check out our free graph representing analyst forecasts.
Our examination of Expedia Group has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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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