Seremban Engineering Berhad's (KLSE:SEB) Solid Profits Have Weak Fundamentals

Despite posting some strong earnings, the market for Seremban Engineering Berhad's (KLSE:SEB) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.

Check out our latest analysis for Seremban Engineering Berhad

Examining Cashflow Against Seremban Engineering Berhad'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2021, Seremban Engineering Berhad recorded an accrual ratio of 0.42. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of RM18m, in contrast to the aforementioned profit of RM6.75m. It's worth noting that Seremban Engineering Berhad generated positive FCF of RM11m a year ago, so at least they've done it in the past. One positive for Seremban Engineering Berhad 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 Seremban Engineering Berhad.

Our Take On Seremban Engineering Berhad's Profit Performance

As we have made quite clear, we're a bit worried that Seremban Engineering Berhad didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Seremban Engineering Berhad's underlying earnings power is lower than its statutory profit. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. 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. To that end, you should learn about the 3 warning signs we've spotted with Seremban Engineering Berhad (including 2 which are concerning).

This note has only looked at a single factor that sheds light on the nature of Seremban Engineering Berhad's 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.