Palms Sports PJSC's (ADX:PALMS) Conservative Accounting Might Explain Soft Earnings

The market for Palms Sports PJSC's (ADX:PALMS) shares didn't move much after it posted weak earnings recently. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

View our latest analysis for Palms Sports PJSC

A Closer Look At Palms Sports PJSC's Earnings

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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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 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".

For the year to December 2023, Palms Sports PJSC had an accrual ratio of -0.16. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of د.إ143m during the period, dwarfing its reported profit of د.إ105.3m. Palms Sports 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 Palms Sports PJSC.

Our Take On Palms Sports PJSC's Profit Performance

Palms Sports PJSC's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Palms Sports PJSC's earnings potential is at least as good as it seems, and maybe even better! And the EPS is up 26% annually, over the last three years. 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. So while earnings quality is important, it's equally important to consider the risks facing Palms Sports PJSC at this point in time. You'd be interested to know, that we found 2 warning signs for Palms Sports PJSC and you'll want to know about these.

This note has only looked at a single factor that sheds light on the nature of Palms Sports PJSC'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 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.