We Think That There Are More Issues For Zvi Sarfati & Sons Investments & Constructions (TLV:SRFT) Than Just Sluggish Earnings

The market rallied behind Zvi Sarfati & Sons Investments & Constructions Ltd.'s (TLV:SRFT) stock, leading do a rise in the share price after its recent weak earnings report. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for Zvi Sarfati & Sons Investments & Constructions.

See our latest analysis for Zvi Sarfati & Sons Investments & Constructions

Zooming In On Zvi Sarfati & Sons Investments & Constructions' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2023, Zvi Sarfati & Sons Investments & Constructions recorded an accrual ratio of 0.39. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of ₪93.6m, a look at free cash flow indicates it actually burnt through ₪193m in the last year. We saw that FCF was ₪241m a year ago though, so Zvi Sarfati & Sons Investments & Constructions has at least been able to generate positive FCF in the past. One positive for Zvi Sarfati & Sons Investments & Constructions 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. 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 Zvi Sarfati & Sons Investments & Constructions.

Our Take On Zvi Sarfati & Sons Investments & Constructions' Profit Performance

As we have made quite clear, we're a bit worried that Zvi Sarfati & Sons Investments & Constructions didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Zvi Sarfati & Sons Investments & Constructions' underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. While conducting our analysis, we found that Zvi Sarfati & Sons Investments & Constructions has 2 warning signs and it would be unwise to ignore them.

Today we've zoomed in on a single data point to better understand the nature of Zvi Sarfati & Sons Investments & Constructions' 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.