Should You Use Baazeem Trading's (TADAWUL:4051) Statutory Earnings To Analyse It?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether Baazeem Trading's (TADAWUL:4051) statutory profits are a good guide to its underlying earnings.

We like the fact that Baazeem Trading made a profit of ر.س25.5m on its revenue of ر.س331.6m, in the last year. The chart below shows that revenue has been flat over the last three years, while profit has actually declined.

See our latest analysis for Baazeem Trading

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what Baazeem Trading's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Baazeem Trading.

Examining Cashflow Against Baazeem Trading's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2020, Baazeem Trading had an accrual ratio of -0.14. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of ر.س52m, well over the ر.س25.5m it reported in profit. Baazeem Trading did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.

Our Take On Baazeem Trading's Profit Performance

As we discussed above, Baazeem Trading has perfectly satisfactory free cash flow relative to profit. Because of this, we think Baazeem Trading's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share increased by 25% in the last year. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To help with this, we've discovered 2 warning signs (1 is concerning!) that you ought to be aware of before buying any shares in Baazeem Trading.

This note has only looked at a single factor that sheds light on the nature of Baazeem Trading'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. 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. 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.
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