Why Thorn Group's (ASX:TGA) Earnings Are Better Than They Seem

Thorn Group Limited's (ASX:TGA) solid earnings announcement recently didn't do much to the stock price. Our analysis suggests that shareholders might be missing some positive underlying factors in the earnings report.

Check out our latest analysis for Thorn Group

Examining Cashflow Against Thorn Group'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). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. 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 March 2021, Thorn Group had an accrual ratio of -0.74. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of AU$210m, well over the AU$8.40m it reported in profit. Notably, Thorn Group had negative free cash flow last year, so the AU$210m 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.

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

How Do Unusual Items Influence Profit?

On top of the noteworthy accrual ratio and the spike in non-operating revenue, we can also see that Thorn Group suffered from unusual items, which reduced profit by AU$2.2m in the last twelve months. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. If Thorn Group doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Thorn Group's Profit Performance

In conclusion, both Thorn Group's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Thorn Group's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you want to do dive deeper into Thorn Group, you'd also look into what risks it is currently facing. For example, we've found that Thorn Group has 5 warning signs (1 is a bit unpleasant!) that deserve your attention before going any further with your analysis.

After our examination into the nature of Thorn Group'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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