Broadly speaking, profitable businesses are less risky than unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we’ll look at how useful this year’s statutory profit is, when analysing Questor Technology (CVE:QST).
We like the fact that Questor Technology made a profit of CA$3.05m on its revenue of CA$20.6m, in the last year. Happily, it has grown both its profit and revenue over the last three years (but not in the last year), as you can see in the chart below.
Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. As a result, today we’re going to take a closer look at Questor Technology’s cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. 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 Questor Technology’s Earnings
In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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”.
Questor Technology has an accrual ratio of -0.11 for the year to June 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of CA$5.5m during the period, dwarfing its reported profit of CA$3.05m. Questor Technology shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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.
The Impact Of Unusual Items On Profit
Questor Technology’s profit was reduced by unusual items worth CA$839.3k 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. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that’s exactly what the accounting terminology implies. Assuming those unusual expenses don’t come up again, we’d therefore expect Questor Technology to produce a higher profit next year, all else being equal.
Our Take On Questor Technology’s Profit Performance
Considering both Questor Technology’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 Questor Technology’s underlying earnings power is at least as good as the statutory numbers would make it seem. So while earnings quality is important, it’s equally important to consider the risks facing Questor Technology at this point in time. For example, we’ve discovered 2 warning signs that you should run your eye over to get a better picture of Questor Technology.
After our examination into the nature of Questor Technology’s profit, we’ve come away optimistic for the company. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
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This article by Simply Wall St is general in nature. 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.
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