We Think C-Lab's (TLV:CLAB) Robust Earnings Are Conservative

C-Lab Ltd's (TLV:CLAB) strong earnings report was rewarded with a positive stock price move. We have done some analysis, and we found several positive factors beyond the profit numbers.

View our latest analysis for C-Lab

A Closer Look At C-Lab's 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

C-Lab has an accrual ratio of -0.11 for the year to December 2022. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of ₪11m during the period, dwarfing its reported profit of ₪6.98m. Given that C-Lab had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₪11m 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 C-Lab.

Our Take On C-Lab's Profit Performance

As we discussed above, C-Lab has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that C-Lab's statutory profit actually understates its earnings potential! Furthermore, it has done a great job growing EPS over the last year. 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. So while earnings quality is important, it's equally important to consider the risks facing C-Lab at this point in time. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of C-Lab.

This note has only looked at a single factor that sheds light on the nature of C-Lab'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. 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.