We Think SEG International Bhd's (KLSE:SEG) Statutory Profit Might Understate Its Earnings Potential

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding SEG International Bhd (KLSE:SEG).

While SEG International Bhd was able to generate revenue of RM210.6m in the last twelve months, we think its profit result of RM40.8m was more important. As depicted below, while its revenue may have fallen over the last few years, its profit actually improved.

See our latest analysis for SEG International Bhd

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what SEG International Bhd'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 SEG International Bhd.

Examining Cashflow Against SEG International Bhd'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. 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. 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. 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".

For the year to September 2020, SEG International Bhd had an accrual ratio of -0.40. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of RM67m in the last year, which was a lot more than its statutory profit of RM40.8m. SEG International Bhd's free cash flow improved over the last year, which is generally good to see.

Our Take On SEG International Bhd's Profit Performance

As we discussed above, SEG International Bhd's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think SEG International Bhd's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at 11% per year over the last three years. 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. If you want to do dive deeper into SEG International Bhd, you'd also look into what risks it is currently facing. For example - SEG International Bhd has 1 warning sign we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of SEG International Bhd's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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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