Hydraulic Elements and Systems AD (BUL:4HE) Is Growing Earnings But Are They A Good Guide?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we'll look at how useful this year's statutory profit is, when analysing Hydraulic Elements and Systems AD (BUL:4HE).

While Hydraulic Elements and Systems AD was able to generate revenue of лв53.9m in the last twelve months, we think its profit result of лв5.66m was more important. Even though its revenue is down over the last three years, its profit has actually increased, as you can see, below.

Check out our latest analysis for Hydraulic Elements and Systems AD

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what Hydraulic Elements and Systems AD's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hydraulic Elements and Systems AD.

Examining Cashflow Against Hydraulic Elements and Systems AD's 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. 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. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to December 2020, Hydraulic Elements and Systems AD had an accrual ratio of 0.29. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Even though it reported a profit of лв5.66m, a look at free cash flow indicates it actually burnt through лв4.2m in the last year. It's worth noting that Hydraulic Elements and Systems AD generated positive FCF of лв5.9m a year ago, so at least they've done it in the past. One positive for Hydraulic Elements and Systems AD shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Our Take On Hydraulic Elements and Systems AD's Profit Performance

Hydraulic Elements and Systems AD's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Hydraulic Elements and Systems AD's true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in the 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 Hydraulic Elements and Systems AD, you'd also look into what risks it is currently facing. To that end, you should learn about the 2 warning signs we've spotted with Hydraulic Elements and Systems AD (including 1 which can't be ignored).

This note has only looked at a single factor that sheds light on the nature of Hydraulic Elements and Systems AD's profit. 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. 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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