Domo Activos' (BME:DOMO) Solid Earnings Are Supported By Other Strong Factors

The subdued stock price reaction suggests that Domo Activos, S.A.'s (BME:DOMO) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

Check out our latest analysis for Domo Activos

A Closer Look At Domo Activos' 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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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 June 2023, Domo Activos recorded an accrual ratio of -0.33. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of €10m during the period, dwarfing its reported profit of €3.48m. Given that Domo Activos had negative free cash flow in the prior corresponding period, the trailing twelve month resul of €10m would seem to be a step in the right direction.

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

Our Take On Domo Activos' Profit Performance

Happily for shareholders, Domo Activos produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Domo Activos' statutory profit actually understates its earnings potential! 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 Domo Activos, you'd also look into what risks it is currently facing. You'd be interested to know, that we found 2 warning signs for Domo Activos and you'll want to know about these.

This note has only looked at a single factor that sheds light on the nature of Domo Activos' 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. 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. 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.