Here's Why We Think Ashley Services Group's (ASX:ASH) Statutory Earnings Might Be Conservative

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Ashley Services Group (ASX:ASH).

It's good to see that over the last twelve months Ashley Services Group made a profit of AU$4.67m on revenue of AU$336.8m. The good news is that the company managed to grow its revenue over the last three years, and also move from loss-making to profitable.

Check out our latest analysis for Ashley Services Group

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, we think it's well worth considering what Ashley Services Group's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Ashley Services Group.

A Closer Look At Ashley Services Group'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. 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.

Ashley Services Group has an accrual ratio of -0.47 for the year to July 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of AU$13m during the period, dwarfing its reported profit of AU$4.67m. Ashley Services Group's free cash flow improved over the last year, which is generally good to see.

Our Take On Ashley Services Group's Profit Performance

Happily for shareholders, Ashley Services Group produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Ashley Services Group's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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 want to do dive deeper into Ashley Services Group, you'd also look into what risks it is currently facing. You'd be interested to know, that we found 2 warning signs for Ashley Services Group and you'll want to know about them.

This note has only looked at a single factor that sheds light on the nature of Ashley Services Group's profit. But there are plenty of other ways to inform your opinion of a company. 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 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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