Saudi Automotive Services' (TADAWUL:4050) Earnings Are Weaker Than They Seem

Despite announcing strong earnings, Saudi Automotive Services Company's (TADAWUL:4050) stock was sluggish. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

Check out our latest analysis for Saudi Automotive Services

A Closer Look At Saudi Automotive Services' 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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2023, Saudi Automotive Services recorded an accrual ratio of -0.10. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of ر.س322m, well over the ر.س105.5m it reported in profit. Saudi Automotive Services' free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Saudi Automotive Services' profit was boosted by unusual items worth ر.س67m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. Saudi Automotive Services had a rather significant contribution from unusual items relative to its profit to December 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Saudi Automotive Services' Profit Performance

In conclusion, Saudi Automotive Services' accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Based on these factors, we think it's very unlikely that Saudi Automotive Services' statutory profits make it seem much weaker than it is. So while earnings quality is important, it's equally important to consider the risks facing Saudi Automotive Services at this point in time. Every company has risks, and we've spotted 2 warning signs for Saudi Automotive Services (of which 1 shouldn't be ignored!) you should know about.

Our examination of Saudi Automotive Services has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. 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.