There Are Some Reasons To Suggest That PDZ Holdings Bhd's (KLSE:PDZ) Earnings Are A Poor Reflection Of Profitability

Following the release of a positive earnings report recently, PDZ Holdings Bhd's (KLSE:PDZ) stock performed well. Investors should be cautious however, as there some causes of concern deeper in the numbers.

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Zooming In On PDZ Holdings Bhd'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 2024, PDZ Holdings Bhd recorded an accrual ratio of 2.31. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of RM22m despite its profit of RM8.50m, mentioned above. We also note that PDZ Holdings Bhd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of RM22m. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

See our latest analysis for PDZ Holdings Bhd

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

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by RM856k, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On PDZ Holdings Bhd's Profit Performance

PDZ Holdings Bhd had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at PDZ Holdings Bhd's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into PDZ Holdings Bhd, you'd also look into what risks it is currently facing. For example, we've found that PDZ Holdings Bhd has 4 warning signs (3 can't be ignored!) that deserve your attention before going any further with your analysis.

Our examination of PDZ Holdings Bhd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 with high insider ownership.

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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.