Here's Why We Think Malton Berhad's (KLSE:MALTON) Statutory Earnings Might Be Conservative

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. This article will consider whether Malton Berhad's (KLSE:MALTON) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Malton Berhad made a profit of RM17.9m on revenue of RM1.95b. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

View our latest analysis for Malton 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. Today, we'll discuss Malton Berhad's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Malton Berhad.

A Closer Look At Malton 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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

For the year to September 2020, Malton Berhad had an accrual ratio of -0.35. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of RM533m during the period, dwarfing its reported profit of RM17.9m. Notably, Malton Berhad had negative free cash flow last year, so the RM533m it produced this year was a welcome improvement.

Our Take On Malton Berhad's Profit Performance

As we discussed above, Malton Berhad's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Malton Berhad's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the last year. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that Malton Berhad is showing 4 warning signs in our investment analysis and 2 of those make us uncomfortable...

This note has only looked at a single factor that sheds light on the nature of Malton Berhad's profit. 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. 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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