Investors Shouldn't Be Too Comfortable With Arabian Contracting Services' (TADAWUL:4071) Robust Earnings

Arabian Contracting Services Company's (TADAWUL:4071) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that shareholders have noticed something concerning in the numbers.

See our latest analysis for Arabian Contracting Services

Examining Cashflow Against Arabian Contracting Services' 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 March 2022, Arabian Contracting Services had an accrual ratio of 0.24. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In fact, it had free cash flow of ر.س31m in the last year, which was a lot less than its statutory profit of ر.س241.5m. Arabian Contracting Services shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. One positive for Arabian Contracting Services 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. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Arabian Contracting Services.

Our Take On Arabian Contracting Services' Profit Performance

Arabian Contracting Services didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Arabian Contracting Services' statutory profits are better than its underlying earnings power. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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. If you want to do dive deeper into Arabian Contracting Services, you'd also look into what risks it is currently facing. For example, Arabian Contracting Services has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Arabian Contracting Services' 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. 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.