Investors Can Find Comfort In Teekay's (NYSE:TK) Earnings Quality

Soft earnings didn't appear to concern Teekay Corporation Ltd.'s (NYSE:TK) shareholders over the last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

Check out our latest analysis for Teekay

Examining Cashflow Against Teekay'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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 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 2024, Teekay had an accrual ratio of -0.22. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of US$397m, well over the US$133.8m it reported in profit. Teekay did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie. 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 Teekay.

How Do Unusual Items Influence Profit?

Surprisingly, given Teekay's accrual ratio implied strong cash conversion, its paper profit was actually boosted by US$37m in unusual items. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. If Teekay 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 Teekay's Profit Performance

Teekay'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. Based on these factors, we think that Teekay's profits are a reasonably conservative guide to its underlying profitability. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. If you're interested we have a graphic representation of Teekay's balance sheet.

Our examination of Teekay 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. 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.