We Think You Can Look Beyond Epsilon Energy's (NASDAQ:EPSN) Lackluster Earnings

The market for Epsilon Energy Ltd.'s (NASDAQ:EPSN) shares didn't move much after it posted weak earnings recently. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

See our latest analysis for Epsilon Energy

Examining Cashflow Against Epsilon Energy'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

Epsilon Energy has an accrual ratio of -0.13 for the year to March 2021. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of US$11m during the period, dwarfing its reported profit of US$3.30m. Epsilon Energy's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Epsilon Energy.

Our Take On Epsilon Energy's Profit Performance

Epsilon Energy's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Epsilon Energy's earnings potential is at least as good as it seems, and maybe even better! On the other hand, its EPS actually shrunk in the last twelve months. 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. You'd be interested to know, that we found 2 warning signs for Epsilon Energy and you'll want to know about them.

Today we've zoomed in on a single data point to better understand the nature of Epsilon Energy's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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