Quality of Earnings Analysis: Patterson-UTI Energy Inc (PTEN)

Name of Company Country of Origin/ Exchange Traded Sector Stock Price
Energy – Oil & Gas – Drilling – Oil & Gas Drilling USD18.08
@ 09 Jul 2018
COMPANY PROFILE Patterson-UTI Energy Inc is a North America-based land rig drilling contractors. It operates in three segments namely, Contract Drilling Services, Pressure Pumping Services, and Oil and Natural Gas Exploration and Production.

Patterson-UTI Energy is one of the largest North America-based land rig drilling contractors. Its fleet consists of about 315 land rigs, which it markets to independents and small producers. The firm also operates a pressure pumping division and owns a small financial interest in oil and gas exploration and production assets in Texas and New Mexico.

Stock Code PTEN
Quality of Earnings Analysis Below
A company’s earnings should not be taken at face value. By that we mean that we should look deep into the accounts to gauge the probability that the company may be relying on account techniques to boost earnings. A company that has been showing strong profit growth or is expected to do so usually trades at a high valuation. This may put tremendous pressure on management to announce good growth to the extent of resorting to accounting techniques to do so. On the other hand, a company that is struggling to report growth in its business may also rely on accounting techiques to boost earnings. These methods will catch up with the company one day and when that happens there is usually a large negative earnings surprise and share price decline.
To detect the likelihood of earnings manipulation, two commonly used methods are the Beneish M-Score and the Sloan Accrual Ratio. Since it is difficult for one ratio to catch all occurences of profit manipulation, we put the two scores into a composite to have a better chance to spot earnings manipulation.
The Beneish M-score is a measure the likelihood of a company manipulating its earnings. Based on this formula, a company is more likely to manipulate earnings if:
* Sales is not translating to cash and receivables are growing
* Gross profit margin is declining giving the company pressure to manipulate earnings
* The company is growing its non-tangible assets which may be used to manipulate earnings
* High sales growth puts pressure on the company to continue to report high growth by manipulating earnings
* A lower rate of depreciation may be a sign that the company wants to boost its earnings
* Lower selling and admin expenses as a percentage of sales may point to the fact that some sales may not be real

Patterson-UTI Energy Beneish M-Score

A score of less than -2.22 suggests that the company is not a profit manipulator and a score above -2.22 suggests that the company might be manipulating its profits. The company’s M-score has been erratic. The latest M-Score of the company as at Dec 2017 was 3.82, which suggests that the company might have been manipulating its profits.
The Sloan Accrual Ratio measures the extent to which a firm’s earnings comprise of accrual (i.e. non-cash) items. In other words, the company makes profit but they do not translate to cash because of some of these reasons:
* Sales are made on credit to customers and not yet paid
* Money is spent on buying more inventory
* Increased earnings comes from reducing depreciation expense, which is non-cash
Earnings with high accrual (or non-cash) component are more likely to be reversed in future resulting in earnings disappointment and share price falls.

Patterson-UTI Energy Sloan Accrual Ratio

The latest Sloan Accrual Ratio is negative.
Since it is not possible for one indicator to capture all instances of earnings manipulation, ProThinker employs both methods to arrive at a Composite Score of the company’s earnings quality. A score of 25 and below (the red line) indicates a higher probability that earnings may have been manipulated.

Patterson-UTI Energy Composite Quality of Earnings Index

The quality of the company’s earnings is low and there may be a possibility that profits are inflated.
Determining the quality of a company’s earnings is important because artificially inflated earnings will one day lead to earnings disappointment and share price decline. In order to derive at a fair valuation of a stock, we need to factor in earnings forecasts that are free from manipulation. These earnings estimates are then multiplied by an appropriate PE for the company. Having said that, we should not be relying on PE alone and should be using other valuation indicators to calibrate our forecasts.
The five ratios we use are Price to Earnings, Price to Sales, Price to Cash Flow, Price to Book and Dividend Yield. We use multiple methods to value a stock because each has its benefits as well as shortcomings. Price to Earnings and Price to Cash Flow Ratios relate stock price to profitability but are meaningless when the comany has negative earnings or cash flows. Price to Sales Ratio is more stable because sales are never negative. However, this does not tell us whether the company is able to sell profitably. Price to Book Ratio gives us an indication as to how much we are paying for the company’s assets but it is not directly related to the company’s profitability. Dividend Yield cannot be used for companies that are paying little to no dividends.
While it is important to value stocks based on multiple valuation methods, this often leads to differing views on valuation. One indicator may suggest that a stock is overvalued while another suggest that it is undervalued. This does not help an investor who needs to make a definite decision whether to buy, hold or sell the stock. That is why we advocate the use of a Composite Valuation Indicator, which is derived from the best combination of the five indicators above. A Composite Valuation Indicator will give you ONE conclusion on whether a stock is under or over valued.
To find out more about our valuation methodology, click here. 
Source of Data: Charts are from ProThinker Stock Report. Company description, historical financial statements data and price data are from gurufocus.com. Estimates are from gurufocus and/or 4-traders.com – Thomson Reuters.
Disclaimer: This report is for information purposes only and should not be considered a solicitation to buy or sell any security. Neither ProThinker nor any other party guarantees its accuracy or makes warranties regarding results from its usage. Redistribution is prohibited without the express written consent of ProThinker. Copyright(c) 2018. All rights reserved.