Investors Shouldn't Be Too Comfortable With Excelsior Capital's (ASX:ECL) Earnings

Excelsior Capital Limited's (ASX:ECL) stock was strong after they recently reported robust earnings. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

View our latest analysis for Excelsior Capital

Examining Cashflow Against Excelsior Capital's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Excelsior Capital has an accrual ratio of 1.02 for the year to June 2024. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of AU$8.0m during the period, falling well short of its reported profit of AU$44.7m. Excelsior Capital shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. One positive for Excelsior Capital shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Excelsior Capital.

Our Take On Excelsior Capital's Profit Performance

As we discussed above, we think Excelsior Capital's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Excelsior Capital's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that it earned a profit in the last twelve months, despite its previous loss. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about Excelsior Capital as a business, it's important to be aware of any risks it's facing. For instance, we've identified 3 warning signs for Excelsior Capital (1 is potentially serious) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Excelsior Capital's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.