Investors Can Find Comfort In AYER Holdings Berhad's (KLSE:AYER) Earnings Quality

Shareholders appeared unconcerned with AYER Holdings Berhad's (KLSE:AYER) lackluster earnings report last week. We did some digging, and we believe the earnings are stronger than they seem.

Check out our latest analysis for AYER Holdings Berhad

Zooming In On AYER Holdings 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. 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. 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 June 2021, AYER Holdings Berhad had an accrual ratio of -0.11. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of RM51m during the period, dwarfing its reported profit of RM8.78m. AYER Holdings Berhad's free cash flow improved over the last year, which is generally good to see.

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

Our Take On AYER Holdings Berhad's Profit Performance

As we discussed above, AYER Holdings Berhad has perfectly satisfactory free cash flow relative to profit. Because of this, we think AYER Holdings Berhad's earnings potential is at least as good as it seems, and maybe even better! Unfortunately, though, its earnings per share actually fell back over the last year. 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. So while earnings quality is important, it's equally important to consider the risks facing AYER Holdings Berhad at this point in time. At Simply Wall St, we found 1 warning sign for AYER Holdings Berhad and we think they deserve your attention.

Today we've zoomed in on a single data point to better understand the nature of AYER Holdings 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. 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.
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