NorAm Drilling's (OB:NORAM) Soft Earnings Are Actually Better Than They Appear

Soft earnings didn't appear to concern NorAm Drilling AS' (OB:NORAM) shareholders over the last week. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Check out our latest analysis for NorAm Drilling

A Closer Look At NorAm Drilling'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 2024, NorAm Drilling had an accrual ratio of -0.34. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of US$25m, well over the US$1.67m it reported in profit. NorAm Drilling did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

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 NorAm Drilling's Profit Performance

As we discussed above, NorAm Drilling's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think NorAm Drilling's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in the last twelve months. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. While conducting our analysis, we found that NorAm Drilling has 2 warning signs and it would be unwise to ignore them.

This note has only looked at a single factor that sheds light on the nature of NorAm Drilling's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 with significant insider holdings to be useful.

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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.