Amway (Malaysia) Holdings Berhad's (KLSE:AMWAY) recent weak earnings report didn't cause a big stock movement. However, we believe that investors should be aware of some underlying factors which may be of concern.
Zooming In On Amway (Malaysia) Holdings Berhad's Earnings
In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Amway (Malaysia) Holdings Berhad has an accrual ratio of 0.41 for the year to December 2020. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. To wit, it produced free cash flow of RM26m during the period, falling well short of its reported profit of RM46.9m. Amway (Malaysia) Holdings Berhad shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months.
That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.
Our Take On Amway (Malaysia) Holdings Berhad's Profit Performance
As we have made quite clear, we're a bit worried that Amway (Malaysia) Holdings Berhad didn't back up the last year's profit with free cashflow. For this reason, we think that Amway (Malaysia) Holdings Berhad's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. 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 Amway (Malaysia) Holdings Berhad at this point in time. For instance, we've identified 2 warning signs for Amway (Malaysia) Holdings Berhad (1 can't be ignored) you should be familiar with.
This note has only looked at a single factor that sheds light on the nature of Amway (Malaysia) Holdings 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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