Does i-Stone Group Berhad's (KLSE:ISTONE) Statutory Profit Adequately Reflect Its Underlying Profit?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 i-Stone Group Berhad (KLSE:ISTONE).

We like the fact that i-Stone Group Berhad made a profit of RM5.40m on its revenue of RM61.4m, in the last year. 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.

See our latest analysis for i-Stone Group 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. As a result, today we're going to take a closer look at i-Stone Group Berhad'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 i-Stone Group Berhad.

Zooming In On i-Stone Group Berhad'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. The ratio shows us how much a company's profit exceeds its FCF.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

i-Stone Group Berhad has an accrual ratio of -0.13 for the year to September 2020. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of RM10m in the last year, which was a lot more than its statutory profit of RM5.40m. Notably, i-Stone Group Berhad had negative free cash flow last year, so the RM10m it produced this year was a welcome improvement. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

How Do Unusual Items Influence Profit?

Surprisingly, given i-Stone Group Berhad's accrual ratio implied strong cash conversion, its paper profit was actually boosted by RM1.2m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. If i-Stone Group Berhad doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On i-Stone Group Berhad's Profit Performance

i-Stone Group Berhad's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, we think it's very unlikely that i-Stone Group Berhad's statutory profits make it seem much weaker than it is. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. At Simply Wall St, we found 4 warning signs for i-Stone Group Berhad and we think they deserve your attention.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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.

If you decide to trade i-Stone Group Berhad, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.