Is There More To The Story Than Integrated Research's (ASX:IRI) Earnings Growth?

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Integrated Research's (ASX:IRI) statutory profits are a good guide to its underlying earnings.

We like the fact that Integrated Research made a profit of AU$24.1m on its revenue of AU$110.9m, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years.

View our latest analysis for Integrated Research

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. So today we'll look at what Integrated Research's cashflow tells us about the quality of its earnings. 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.

A Closer Look At Integrated Research'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. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Integrated Research has an accrual ratio of 0.22 for the year to June 2020. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. To wit, it produced free cash flow of AU$8.9m during the period, falling well short of its reported profit of AU$24.1m. We note, however, that Integrated Research grew its free cash flow over the last year.

Our Take On Integrated Research's Profit Performance

Integrated Research didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Integrated Research's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 29% per annum growth in EPS for the last three. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing Integrated Research at this point in time. When we did our research, we found 2 warning signs for Integrated Research (1 is potentially serious!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Integrated Research's profit. 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. 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.

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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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