Electromagnetic Geoservices' (OB:EMGS) Earnings Are Weaker Than They Seem

Last week's profit announcement from Electromagnetic Geoservices ASA (OB:EMGS) was underwhelming for investors, despite headline numbers being robust. We did some digging and found some worrying underlying problems.

See our latest analysis for Electromagnetic Geoservices

Zooming In On Electromagnetic Geoservices' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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".

Electromagnetic Geoservices has an accrual ratio of -0.11 for the year to December 2024. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of US$4.1m during the period, dwarfing its reported profit of US$2.82m. Electromagnetic Geoservices' year-on-year free cash flow was as flat as two-day-old fizzy drink. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Electromagnetic Geoservices.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Electromagnetic Geoservices' profit was boosted by unusual items worth US$733k in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. If Electromagnetic Geoservices doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Electromagnetic Geoservices' Profit Performance

In conclusion, Electromagnetic Geoservices' accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Given the contrasting considerations, we don't have a strong view as to whether Electromagnetic Geoservices's profits are an apt reflection of its underlying potential for profit. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, Electromagnetic Geoservices has 4 warning signs (and 1 which is potentially serious) we think you should know about.

Our examination of Electromagnetic Geoservices has focussed on certain factors that can make its earnings look better than they are. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.