We Think UCW's (ASX:UCW) Healthy Earnings Might Be Conservative

The market seemed underwhelmed by last week's earnings announcement from UCW Limited (ASX:UCW) despite the healthy numbers. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.

Check out our latest analysis for UCW

Zooming In On UCW'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'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 2020, UCW recorded an accrual ratio of -0.54. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of AU$7.0m during the period, dwarfing its reported profit of AU$1.72m. UCW shareholders are no doubt pleased that free cash flow improved over the last twelve months.

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

Our Take On UCW's Profit Performance

Happily for shareholders, UCW produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think UCW's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And it's also positive that the company showed enough improvement to book a profit this year, after losing money 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. If you want to do dive deeper into UCW, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 1 warning sign for UCW you should know about.

Today we've zoomed in on a single data point to better understand the nature of UCW'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. 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.

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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.
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