As a general rule, we think profitable companies are less risky than companies that lose money. 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. Today we’ll focus on whether this year’s statutory profits are a good guide to understanding A.H. Belo (NYSE:AHC).
While A.H. Belo was able to generate revenue of US$196.0m in the last twelve months, we think its profit result of US$12.9m was more important. Even though revenue is down over the last three years, you can see in the chart below that the company has moved from loss-making to profitable.
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 A.H. Belo’s cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of A.H. Belo.
A Closer Look At A.H. Belo’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. The ratio shows us how much a company’s profit exceeds its FCF.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it’s not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
For the year to June 2019, A.H. Belo had an accrual ratio of 0.38. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that’s a real negative for future earnings. Indeed, in the last twelve months it reported free cash flow of US$1.1m, which is significantly less than its profit of US$12.9m. Notably, A.H. Belo had negative free cash flow last year, so the US$1.1m 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.
The Impact Of Unusual Items On Profit
Given the accrual ratio, it’s not overly surprising that A.H. Belo’s profit was boosted by unusual items worth US$26m in the last twelve months. While it’s always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that’s as you’d expect, given these boosts are described as ‘unusual’. We can see that A.H. Belo’s positive unusual items were quite significant relative to its profit in the year to June 2019. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.
Our Take On A.H. Belo’s Profit Performance
A.H. Belo had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at A.H. Belo’s statutory profits might make it look better than it really is on an underlying level. In light of this, if you’d like to do more analysis on the company, it’s vital to be informed of the risks involved. For instance, we’ve identified 6 warning signs for A.H. Belo (2 shouldn’t be ignored) you should be familiar with.
In this article we’ve looked at a number of factors that can impair the utility of profit numbers, and we’ve come away cautious. 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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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