Investors Shouldn't Be Too Comfortable With PetroNor E&P's (OB:PNOR) Earnings

PetroNor E&P ASA's (OB:PNOR) stock was strong after they recently reported robust earnings. However, we think that shareholders may be missing some concerning details in the numbers.

See our latest analysis for PetroNor E&P

Zooming In On PetroNor E&P'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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".

PetroNor E&P has an accrual ratio of 0.33 for the year to December 2023. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Indeed, in the last twelve months it reported free cash flow of US$9.8m, which is significantly less than its profit of US$49.9m. Notably, PetroNor E&P had negative free cash flow last year, so the US$9.8m 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 PetroNor E&P.

Our Take On PetroNor E&P's Profit Performance

As we discussed above, we think PetroNor E&P's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that PetroNor E&P's underlying earnings power is lower than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you want to do dive deeper into PetroNor E&P, you'd also look into what risks it is currently facing. Case in point: We've spotted 1 warning sign for PetroNor E&P you should be aware of.

This note has only looked at a single factor that sheds light on the nature of PetroNor E&P's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. 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 that insiders are buying 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.