Is There More To The Story Than Ralco Agencies's (TLV:RLCO) Earnings Growth?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Ralco Agencies (TLV:RLCO).

We like the fact that Ralco Agencies made a profit of ₪16.7m on its revenue of ₪210.0m, in the last year. The chart below shows how profit has actually increased over the last three years, even while revenue has declined.

View our latest analysis for Ralco Agencies

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what Ralco Agencies' 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 Ralco Agencies.

A Closer Look At Ralco Agencies' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

Over the twelve months to June 2020, Ralco Agencies recorded an accrual ratio of -0.20. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of ₪33m during the period, dwarfing its reported profit of ₪16.7m. Ralco Agencies shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Ralco Agencies' Profit Performance

Happily for shareholders, Ralco Agencies produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Ralco Agencies' statutory profit actually understates its earnings potential! And the EPS is up 41% annually, 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. You'd be interested to know, that we found 2 warning signs for Ralco Agencies and you'll want to know about these.

Today we've zoomed in on a single data point to better understand the nature of Ralco Agencies' profit. But there are plenty of other ways to inform your opinion of a company. 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. 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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