Unsurprisingly, Pure Hydrogen Corporation Limited's (ASX:PH2) stock price was strong on the back of its healthy earnings report. However, we think that shareholders may be missing some concerning details in the numbers.
Examining Cashflow Against Pure Hydrogen'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Pure Hydrogen has an accrual ratio of 0.22 for the year to December 2022. Unfortunately, that means its free cash flow fell significantly short of its reported profits. To wit, it produced free cash flow of AU$1.8m during the period, falling well short of its reported profit of AU$5.48m. Given that Pure Hydrogen had negative free cash flow in the prior corresponding period, the trailing twelve month resul of AU$1.8m would seem to be a step in the right direction. The good news for shareholders is that Pure Hydrogen's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Pure Hydrogen.
Our Take On Pure Hydrogen's Profit Performance
Pure Hydrogen didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Pure Hydrogen's true underlying earnings power is actually less than its statutory profit. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. 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. If you'd like to know more about Pure Hydrogen as a business, it's important to be aware of any risks it's facing. For example, Pure Hydrogen has 4 warning signs (and 2 which are concerning) we think you should know about.
This note has only looked at a single factor that sheds light on the nature of Pure Hydrogen'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. 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.