The market for MEG Energy Corp.’s (TSE:MEG) shares didn’t move much after it posted weak earnings recently. We did some digging, and we believe the earnings are stronger than they seem.
View our latest analysis for MEG Energy
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. The ratio shows us how much a company’s profit exceeds its FCF.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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.
Over the twelve months to September 2024, MEG Energy recorded an accrual ratio of -0.11. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of CA$1.1b in the last year, which was a lot more than its statutory profit of CA$504.0m. MEG Energy shareholders are no doubt pleased that free cash flow improved over the last twelve months.
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.
MEG Energy’s accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that MEG Energy’s statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. At the end of the day, it’s essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it’s equally important to consider the risks facing MEG Energy at this point in time. You’d be interested to know, that we found 1 warning sign for MEG Energy and you’ll want to know about it.
This note has only looked at a single factor that sheds light on the nature of MEG Energy’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.