Should You Use Overseas Commerce's (TLV:OVRS) Statutory Earnings To Analyse It?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 Overseas Commerce (TLV:OVRS).

While Overseas Commerce was able to generate revenue of ₪320.8m in the last twelve months, we think its profit result of ₪23.0m was more important. 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.

View our latest analysis for Overseas Commerce

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, today we're going to take a closer look at Overseas Commerce's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Overseas Commerce.

Zooming In On Overseas Commerce's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Overseas Commerce has an accrual ratio of -0.17 for the year to September 2020. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of ₪78m in the last year, which was a lot more than its statutory profit of ₪23.0m. Overseas Commerce's free cash flow improved over the last year, which is generally good to see. 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.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Overseas Commerce's profit was boosted by unusual items worth ₪6.2m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Overseas Commerce's Profit Performance

In conclusion, Overseas Commerce's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Based on these factors, we think that Overseas Commerce's profits are a reasonably conservative guide to its underlying profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 5 warning signs for Overseas Commerce you should be mindful of and 2 of these can't be ignored.

Our examination of Overseas Commerce has focussed on certain factors that can make its earnings look better than they are. 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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