TAFI Industries Berhad's (KLSE:TAFI) Earnings Are Of Questionable Quality

TAFI Industries Berhad's (KLSE:TAFI) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

View our latest analysis for TAFI Industries Berhad

A Closer Look At TAFI Industries Berhad'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.

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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

TAFI Industries Berhad has an accrual ratio of 0.79 for the year to June 2022. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of RM7.73m, a look at free cash flow indicates it actually burnt through RM31m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of RM31m, this year, indicates high risk. The good news for shareholders is that TAFI Industries Berhad'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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of TAFI Industries Berhad.

Our Take On TAFI Industries Berhad's Profit Performance

As we discussed above, we think TAFI Industries Berhad's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that TAFI Industries Berhad's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you want to do dive deeper into TAFI Industries Berhad, you'd also look into what risks it is currently facing. Our analysis shows 4 warning signs for TAFI Industries Berhad (2 are potentially serious!) and we strongly recommend you look at these before investing.

Today we've zoomed in on a single data point to better understand the nature of TAFI Industries Berhad's profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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. 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.