Rainbow Chicken's (JSE:RBO) Strong Earnings Are Of Good Quality

The subdued stock price reaction suggests that Rainbow Chicken Limited's (JSE:RBO) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

See our latest analysis for Rainbow Chicken

A Closer Look At Rainbow Chicken'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.

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. 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.

For the year to June 2024, Rainbow Chicken had an accrual ratio of -0.14. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of R795m during the period, dwarfing its reported profit of R180.2m. Given that Rainbow Chicken had negative free cash flow in the prior corresponding period, the trailing twelve month resul of R795m 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 Rainbow Chicken.

Our Take On Rainbow Chicken's Profit Performance

Rainbow Chicken's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Rainbow Chicken's earnings potential is at least as good as it seems, and maybe even better! 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. Just as investors must consider earnings, it is also important to take into account the strength of a company's balance sheet. We've done some analysis and you can see our take on Rainbow Chicken's balance sheet by clicking here.

This note has only looked at a single factor that sheds light on the nature of Rainbow Chicken'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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.