Beyond Lackluster Earnings: Potential Concerns For Aura Investments' (TLV:AURA) Shareholders

Aura Investments Ltd.'s (TLV:AURA) weak earnings were disregarded by the market. Despite the strength in the stock, we feel that investors should be cautious about some numbers in the earnings.

Check out our latest analysis for Aura Investments

Examining Cashflow Against Aura Investments' 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. 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2023, Aura Investments recorded an accrual ratio of 0.38. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of ₪117.7m, a look at free cash flow indicates it actually burnt through ₪566m in the last year. We saw that FCF was ₪163m a year ago though, so Aura Investments has at least been able to generate positive FCF in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio. The good news for shareholders is that Aura Investments' 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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by ₪35m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. If Aura Investments doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Aura Investments' Profit Performance

Aura Investments had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Aura Investments' profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Aura Investments as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for Aura Investments (2 don't sit too well with us!) that we believe deserve your full attention.

Our examination of Aura Investments has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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.