We Think That There Are Issues Underlying Baumart Holdings' (ASX:BMH) Earnings

Baumart Holdings Limited (ASX:BMH) announced strong profits, but the stock was stagnant. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

See our latest analysis for Baumart Holdings

Zooming In On Baumart Holdings' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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. 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 December 2020, Baumart Holdings recorded an accrual ratio of 1.17. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of AU$262k despite its profit of AU$3.47m, mentioned above. We also note that Baumart Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of AU$262k.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Baumart Holdings.

Our Take On Baumart Holdings' Profit Performance

As we have made quite clear, we're a bit worried that Baumart Holdings didn't back up the last year's profit with free cashflow. For this reason, we think that Baumart Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that Baumart Holdings is showing 4 warning signs in our investment analysis and 1 of those makes us a bit uncomfortable...

Today we've zoomed in on a single data point to better understand the nature of Baumart Holdings' 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

When trading Baumart Holdings or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.