Olam Group's (SGX:VC2) Solid Earnings May Rest On Weak Foundations

Olam Group Limited's (SGX:VC2 ) stock didn't jump after it announced some healthy earnings. We did some digging and believe investors may be worried about some underlying factors in the report.

Check out our latest analysis for Olam Group

A Closer Look At Olam Group'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. 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".

Over the twelve months to June 2024, Olam Group recorded an accrual ratio of 0.27. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of S$5.8b despite its profit of S$246.2m, mentioned above. We also note that Olam Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of S$5.8b.

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

Our Take On Olam Group's Profit Performance

Olam Group's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Olam Group's true underlying earnings power is actually less than its statutory profit. But at least holders can take some solace from the 21% EPS growth in the last year. 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. If you want to do dive deeper into Olam Group, you'd also look into what risks it is currently facing. You'd be interested to know, that we found 3 warning signs for Olam Group and you'll want to know about these.

Today we've zoomed in on a single data point to better understand the nature of Olam Group'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 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.