ASM Group S.A.'s (WSE:ASM) stock rose after it released a robust earnings report. While the headline numbers were strong, we found some underlying problems once we started looking at what drove earnings.
A Closer Look At ASM Group's Earnings
As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.
Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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".
For the year to June 2021, ASM Group had an accrual ratio of 0.38. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of zł5.4m despite its profit of zł28.0m, mentioned above. It's worth noting that ASM Group generated positive FCF of zł15m a year ago, so at least they've done it in the past. 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. One positive for ASM Group shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of ASM Group.
How Do Unusual Items Influence Profit?
Given the accrual ratio, it's not overly surprising that ASM Group's profit was boosted by unusual items worth zł31m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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'. ASM Group had a rather significant contribution from unusual items relative to its profit to June 2021. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.
Our Take On ASM Group's Profit Performance
ASM Group had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue ASM Group's profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 5 warning signs for ASM Group (of which 4 are a bit unpleasant!) you should know about.
Our examination of ASM Group has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.
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.
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