The Strong Earnings Posted By Smith-Midland (NASDAQ:SMID) Are A Good Indication Of The Strength Of The Business

When companies post strong earnings, the stock generally performs well, just like Smith-Midland Corporation's (NASDAQ:SMID) stock has recently. We have done some analysis, and we found several positive factors beyond the profit numbers.

View our latest analysis for Smith-Midland

Examining Cashflow Against Smith-Midland's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2021, Smith-Midland recorded an accrual ratio of -0.12. 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$8.2m during the period, dwarfing its reported profit of US$5.57m. Given that Smith-Midland had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$8.2m would seem to be a step in the right direction.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Smith-Midland.

Our Take On Smith-Midland's Profit Performance

As we discussed above, Smith-Midland has perfectly satisfactory free cash flow relative to profit. Because of this, we think Smith-Midland's earnings potential is at least as good as it seems, and maybe even better! Better yet, its EPS are growing strongly, which is nice to see. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. In terms of investment risks, we've identified 2 warning signs with Smith-Midland, and understanding these should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Smith-Midland's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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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