Shareholders Shouldn’t Be Too Comfortable With ESG Emirates Stallions Group PJSC's (ADX:ESG) Strong Earnings

Investors were disappointed with ESG Emirates Stallions Group PJSC's (ADX:ESG) recent earnings release. We did some analysis and believe that they might be concerned about some weak underlying factors.

Check out our latest analysis for ESG Emirates Stallions Group PJSC

A Closer Look At ESG Emirates Stallions Group 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. The ratio shows us how much a company's profit exceeds its FCF.

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

Over the twelve months to December 2023, ESG Emirates Stallions Group PJSC recorded an accrual ratio of 0.48. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. In fact, it had free cash flow of د.إ175m in the last year, which was a lot less than its statutory profit of د.إ668.0m. At this point we should mention that ESG Emirates Stallions Group PJSC did manage to increase its free cash flow in the last twelve months Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of ESG Emirates Stallions Group PJSC.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that ESG Emirates Stallions Group PJSC's profit was boosted by unusual items worth د.إ563m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. We can see that ESG Emirates Stallions Group PJSC's positive unusual items were quite significant relative to its profit in the year to December 2023. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On ESG Emirates Stallions Group PJSC's Profit Performance

ESG Emirates Stallions Group PJSC had a weak accrual ratio, but its profit did receive a boost from unusual items. On reflection, the above-mentioned factors give us the strong impression that ESG Emirates Stallions Group PJSC'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. While conducting our analysis, we found that ESG Emirates Stallions Group PJSC has 2 warning signs and it would be unwise to ignore them.

Our examination of ESG Emirates Stallions Group PJSC has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 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.