Despite announcing strong earnings, McMillan Shakespeare Limited’s (ASX:MMS) stock was sluggish. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.
View our latest analysis for McMillan Shakespeare
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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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 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.
McMillan Shakespeare has an accrual ratio of 0.49 for the year to June 2024. Statistically speaking, that’s a real negative for future earnings. And indeed, during the period the company didn’t produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of AU$128m despite its profit of AU$90.1m, mentioned above. It’s worth noting that McMillan Shakespeare generated positive FCF of AU$8.3m a year ago, so at least they’ve done it in the past.
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.
As we have made quite clear, we’re a bit worried that McMillan Shakespeare didn’t back up the last year’s profit with free cashflow. As a result, we think it may well be the case that McMillan Shakespeare’s underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 64% per annum growth in EPS for the last three. Of course, we’ve only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn’t consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We’ve spotted 3 warning signs for McMillan Shakespeare you should be aware of.
Today we’ve zoomed in on a single data point to better understand the nature of McMillan Shakespeare’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.