Why Smart Organic AD's (BUL:SO) Earnings Are Better Than They Seem

Smart Organic AD's (BUL:SO) solid earnings announcement recently didn't do much to the stock price. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

View our latest analysis for Smart Organic AD

A Closer Look At Smart Organic AD's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

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. 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. 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 2023, Smart Organic AD recorded an accrual ratio of 0.28. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of лв12.2m, a look at free cash flow indicates it actually burnt through лв79k in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of лв79k, this year, indicates high risk. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

How Do Unusual Items Influence Profit?

Finally, we should also talk about the лв13m in unusual items that weighed on profit over the year. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. In the twelve months to December 2023, Smart Organic AD had a big unusual items expense. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On Smart Organic AD's Profit Performance

In conclusion, Smart Organic AD's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. After taking into account all these factors, we think that Smart Organic AD's statutory results are a decent reflection of its underlying earnings power. If you want to do dive deeper into Smart Organic AD, you'd also look into what risks it is currently facing. While conducting our analysis, we found that Smart Organic AD has 1 warning sign and it would be unwise to ignore this.

Our examination of Smart Organic AD has focussed on certain factors that can make its earnings look better than they are. 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.

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

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.