Solid Earnings May Not Tell The Whole Story For BP Plastics Holding Bhd (KLSE:BPPLAS)

BP Plastics Holding Bhd.'s (KLSE:BPPLAS ) stock didn't jump after it announced some healthy earnings. We think that investors might be worried about some concerning underlying factors.

View our latest analysis for BP Plastics Holding Bhd

A Closer Look At BP Plastics Holding Bhd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

Over the twelve months to March 2024, BP Plastics Holding Bhd recorded an accrual ratio of 0.26. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of RM12m, in contrast to the aforementioned profit of RM34.6m. We saw that FCF was RM38m a year ago though, so BP Plastics Holding Bhd has at least been able to generate positive FCF in the past. One positive for BP Plastics Holding Bhd 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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On BP Plastics Holding Bhd's Profit Performance

BP Plastics Holding Bhd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that BP Plastics Holding Bhd's true underlying earnings power is actually less than its statutory profit. The good news is that, its earnings per share increased by 10% in the 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. So while earnings quality is important, it's equally important to consider the risks facing BP Plastics Holding Bhd at this point in time. Case in point: We've spotted 3 warning signs for BP Plastics Holding Bhd you should be mindful of and 1 of these is potentially serious.

Today we've zoomed in on a single data point to better understand the nature of BP Plastics Holding Bhd'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. 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 with significant insider holdings 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.