Harrisons Holdings (Malaysia) Berhad (KLSE:HARISON) Is Growing Earnings But Are They A Good Guide?

Broadly speaking, profitable businesses are less risky than 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. This article will consider whether Harrisons Holdings (Malaysia) Berhad's (KLSE:HARISON) statutory profits are a good guide to its underlying earnings.

While Harrisons Holdings (Malaysia) Berhad was able to generate revenue of RM1.79b in the last twelve months, we think its profit result of RM27.1m was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years.

Check out our latest analysis for Harrisons Holdings (Malaysia) Berhad

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 Harrisons Holdings (Malaysia) Berhad's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Harrisons Holdings (Malaysia) Berhad.

Examining Cashflow Against Harrisons Holdings (Malaysia) Berhad's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Harrisons Holdings (Malaysia) Berhad has an accrual ratio of -0.41 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. To wit, it produced free cash flow of RM154m during the period, dwarfing its reported profit of RM27.1m. Harrisons Holdings (Malaysia) Berhad's free cash flow improved over the last year, which is generally good to see.

Our Take On Harrisons Holdings (Malaysia) Berhad's Profit Performance

Happily for shareholders, Harrisons Holdings (Malaysia) Berhad produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Harrisons Holdings (Malaysia) Berhad's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 22% per year over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example - Harrisons Holdings (Malaysia) Berhad has 2 warning signs we think you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Harrisons Holdings (Malaysia) Berhad's 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. 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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