Shareholders Can Be Confident That Alpha Dhabi Holding PJSC's (ADX:ALPHADHABI) Earnings Are High Quality

Alpha Dhabi Holding PJSC (ADX:ALPHADHABI) just reported healthy earnings but the stock price didn't move much. We think that investors have missed some encouraging factors underlying the profit figures.

Check out our latest analysis for Alpha Dhabi Holding PJSC

A Closer Look At Alpha Dhabi Holding PJSC'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2021, Alpha Dhabi Holding PJSC had an accrual ratio of -0.36. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of د.إ7.4b in the last year, which was a lot more than its statutory profit of د.إ3.18b. Alpha Dhabi Holding PJSC's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Alpha Dhabi Holding PJSC.

Our Take On Alpha Dhabi Holding PJSC's Profit Performance

As we discussed above, Alpha Dhabi Holding PJSC's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Alpha Dhabi Holding PJSC's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the last year. 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. Just as investors must consider earnings, it is also important to take into account the strength of a company's balance sheet. If you're interested we have a graphic representation of Alpha Dhabi Holding PJSC's balance sheet.

This note has only looked at a single factor that sheds light on the nature of Alpha Dhabi Holding PJSC's profit. 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.