Are Matrix IT's (TLV:MTRX) Statutory Earnings A Good Guide To Its Underlying Profitability?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Matrix IT's (TLV:MTRX) statutory profits are a good guide to its underlying earnings.

While Matrix IT was able to generate revenue of ₪3.71b in the last twelve months, we think its profit result of ₪165.1m was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years.

Check out our latest analysis for Matrix IT

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. So today we'll look at what Matrix IT's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Matrix IT.

Zooming In On Matrix IT's 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. The ratio shows us how much a company's profit exceeds its FCF.

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".

For the year to September 2020, Matrix IT had an accrual ratio of -0.19. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of ₪391m in the last year, which was a lot more than its statutory profit of ₪165.1m. Matrix IT shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Matrix IT's Profit Performance

As we discussed above, Matrix IT's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Matrix IT's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 39% per year over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. In terms of investment risks, we've identified 2 warning signs with Matrix IT, and understanding these should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Matrix IT's 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. 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. 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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