Should You Use TMC Life Sciences Berhad's (KLSE:TMCLIFE) Statutory Earnings To Analyse It?

Statistically speaking, it is less risky to invest in profitable companies than in 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 TMC Life Sciences Berhad (KLSE:TMCLIFE).

We like the fact that TMC Life Sciences Berhad made a profit of RM15.9m on its revenue of RM184.1m, in the last year. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

View our latest analysis for TMC Life Sciences Berhad

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. So today we'll look at what TMC Life Sciences 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 TMC Life Sciences Berhad.

A Closer Look At TMC Life Sciences 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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

TMC Life Sciences Berhad has an accrual ratio of 0.25 for the year to June 2020. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of RM15.9m, a look at free cash flow indicates it actually burnt through RM146m in the last year. We also note that TMC Life Sciences Berhad's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of RM146m.

Our Take On TMC Life Sciences Berhad's Profit Performance

TMC Life Sciences Berhad didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that TMC Life Sciences Berhad's true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in 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 TMC Life Sciences Berhad at this point in time. For example, TMC Life Sciences Berhad has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of TMC Life Sciences Berhad's profit. 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. 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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