Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it’s not always clear whether statutory profits are a good guide, going forward. In this article, we’ll look at how useful this year’s statutory profit is, when analysing eBay (NASDAQ:EBAY).
We like the fact that eBay made a profit of US$2.10b on its revenue of US$11.2b, in the last year.
Not all profits are equal, and we can learn more about the nature of a company’s past profitability by diving deeper into the financial statements. As a result, today we’re going to take a closer look at eBay’s cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. 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.
A Closer Look At eBay’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. 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. The ratio shows us how much a company’s profit exceeds its FCF.
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. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
eBay has an accrual ratio of -0.11 for the year to June 2020. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of US$2.9b during the period, dwarfing its reported profit of US$2.10b. eBay shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.
The Impact Of Unusual Items On Profit
While the accrual ratio might bode well, we also note that eBay’s profit was boosted by unusual items worth US$226m in the last twelve months. We can’t deny that higher profits generally leave us optimistic, but we’d prefer it if the profit were to be sustainable. 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’. If eBay 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 eBay’s Profit Performance
In conclusion, eBay’s accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Given the contrasting considerations, we don’t have a strong view as to whether eBay’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 eBay at this point in time. Every company has risks, and we’ve spotted 2 warning signs for eBay you should know about.
Our examination of eBay 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. 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.
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This article by Simply Wall St is general in nature. 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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