Solid Automotive Berhad's (KLSE:SOLID) Conservative Accounting Might Explain Soft Earnings

Soft earnings didn't appear to concern Solid Automotive Berhad's (KLSE:SOLID) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

See our latest analysis for Solid Automotive Berhad

A Closer Look At Solid Automotive Berhad's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Solid Automotive Berhad has an accrual ratio of -0.15 for the year to January 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of RM37m during the period, dwarfing its reported profit of RM6.22m. Notably, Solid Automotive Berhad had negative free cash flow last year, so the RM37m it produced this year was a welcome improvement.

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

Our Take On Solid Automotive Berhad's Profit Performance

As we discussed above, Solid Automotive Berhad has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Solid Automotive Berhad's statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at an extremely impressive rate over the last three years. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. In terms of investment risks, we've identified 1 warning sign with Solid Automotive Berhad, and understanding it should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Solid Automotive Berhad's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.