There May Be Some Bright Spots In Ambassador HotelLtd's (TWSE:2704) Earnings

The market shrugged off The Ambassador Hotel,Ltd.'s (TWSE:2704) weak earnings report last week. Our analysis suggests that there are some positive factors lying below the troubling profit numbers which investors are finding comfort in.

Check out our latest analysis for Ambassador HotelLtd

A Closer Look At Ambassador HotelLtd's 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'.

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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to December 2023, Ambassador HotelLtd had an accrual ratio of -0.39. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of NT$2.6b during the period, dwarfing its reported profit of NT$493.0m. Notably, Ambassador HotelLtd had negative free cash flow last year, so the NT$2.6b it produced this year was a welcome improvement. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

The Impact Of Unusual Items On Profit

Surprisingly, given Ambassador HotelLtd's accrual ratio implied strong cash conversion, its paper profit was actually boosted by NT$624m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. Ambassador HotelLtd had a rather significant contribution from unusual items relative to its profit to December 2023. 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 Ambassador HotelLtd's Profit Performance

Ambassador HotelLtd's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Given the contrasting considerations, we don't have a strong view as to whether Ambassador HotelLtd's profits are an apt reflection of its underlying potential for profit. So while earnings quality is important, it's equally important to consider the risks facing Ambassador HotelLtd at this point in time. You'd be interested to know, that we found 3 warning signs for Ambassador HotelLtd and you'll want to know about them.

Our examination of Ambassador HotelLtd 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 that insiders are buying.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.