Should You Use FCW Holdings Berhad's (KLSE:FCW) Statutory Earnings To Analyse It?

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. Today we'll focus on whether this year's statutory profits are a good guide to understanding FCW Holdings Berhad (KLSE:FCW).

While FCW Holdings Berhad was able to generate revenue of RM21.1m in the last twelve months, we think its profit result of RM22.5m was more important.

Check out our latest analysis for FCW Holdings Berhad

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, we think it's well worth considering what FCW Holdings Berhad's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of FCW Holdings Berhad.

Examining Cashflow Against FCW 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). 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. 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 June 2020, FCW Holdings Berhad had an accrual ratio of 0.27. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. To wit, it produced free cash flow of RM2.7m during the period, falling well short of its reported profit of RM22.5m. We note, however, that FCW Holdings Berhad grew its free cash flow over the last year.

Our Take On FCW Holdings Berhad's Profit Performance

FCW Holdings Berhad didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that FCW Holdings Berhad's statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 14% EPS growth 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 3 warning signs for FCW Holdings Berhad (1 is concerning!) and we strongly recommend you look at these before investing.

This note has only looked at a single factor that sheds light on the nature of FCW Holdings 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. 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.

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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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