Broadly speaking, profitable businesses are less risky than unprofitable ones. 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. In this article, we'll look at how useful this year's statutory profit is, when analysing Oxford Metrics (LON:OMG).
It's good to see that over the last twelve months Oxford Metrics made a profit of UK£1.60m on revenue of UK£30.3m. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.
Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what Oxford Metrics' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. 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 Oxford Metrics' 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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.
Oxford Metrics has an accrual ratio of -0.12 for the year to September 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of UK£3.4m, well over the UK£1.60m it reported in profit. Oxford Metrics did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.
Our Take On Oxford Metrics' Profit Performance
Oxford Metrics' accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Oxford Metrics' earnings potential is at least as good as it seems, and maybe even better! 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. So while earnings quality is important, it's equally important to consider the risks facing Oxford Metrics at this point in time. To help with this, we've discovered 3 warning signs (1 can't be ignored!) that you ought to be aware of before buying any shares in Oxford Metrics.
Today we've zoomed in on a single data point to better understand the nature of Oxford Metrics' profit. 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. 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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