Dna Group (T.R.)'s (TLV:DNA) Earnings Are Built On Soft Foundations

Shareholders were pleased with the recent earnings report from Dna Group (T.R.) Ltd (TLV:DNA). Despite this, we feel that there are some reasons to be cautious with these earnings.

See our latest analysis for Dna Group (T.R.)

Examining Cashflow Against Dna Group (T.R.)'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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 December 2024, Dna Group (T.R.) had an accrual ratio of 0.90. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of ₪1.6m during the period, falling well short of its reported profit of ₪22.1m. Notably, Dna Group (T.R.) had negative free cash flow last year, so the ₪1.6m it produced this year was a welcome improvement. 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 Dna Group (T.R.)'s 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. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Dna Group (T.R.).

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by ₪21m, 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 analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. Dna Group (T.R.) had a rather significant contribution from unusual items relative to its profit to December 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Dna Group (T.R.)'s Profit Performance

Summing up, Dna Group (T.R.) received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For all the reasons mentioned above, we think that, at a glance, Dna Group (T.R.)'s statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, Dna Group (T.R.) has 4 warning signs (and 2 which are a bit concerning) we think you should know about.

Our examination of Dna Group (T.R.) 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 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 with high insider ownership.

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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.