LMS Compliance Ltd.’s (Catalist:LMS) robust earnings report didn’t manage to move the market for its stock. Our analysis suggests that shareholders have noticed something concerning in the numbers.
See our latest analysis for LMS Compliance
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. 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
For the year to June 2024, LMS Compliance had 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 fact, it had free cash flow of RM3.0m in the last year, which was a lot less than its statutory profit of RM5.58m. Notably LMS Compliance’s free cash flow was stable over the last year. The good news for shareholders is that LMS Compliance’s accrual ratio was much better last year, so this year’s poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of LMS Compliance.
LMS Compliance’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. Because of this, we think that it may be that LMS Compliance’s statutory profits are better than its underlying earnings power. The silver lining is that its EPS growth over the last year has been really wonderful, even if it’s not a perfect measure. 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. So if you’d like to dive deeper into this stock, it’s crucial to consider any risks it’s facing. Our analysis shows 3 warning signs for LMS Compliance (2 are potentially serious!) and we strongly recommend you look at these before investing.
This note has only looked at a single factor that sheds light on the nature of LMS Compliance’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. 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.