There May Be Reason For Hope In Allied Electronics' (JSE:AEL) Disappointing Earnings

Allied Electronics Corporation Limited's (JSE:AEL) stock was strong despite it releasing a soft earnings report last week. Our analysis suggests that investors may have noticed some promising signs beyond the statutory profit figures.

Check out our latest analysis for Allied Electronics

Examining Cashflow Against Allied Electronics' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to February 2021, Allied Electronics had an accrual ratio of -0.29. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of R1.4b during the period, dwarfing its reported profit of R86.0m. Allied Electronics' 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 Allied Electronics.

Our Take On Allied Electronics' Profit Performance

As we discussed above, Allied Electronics' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Allied Electronics' statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Allied Electronics.

Today we've zoomed in on a single data point to better understand the nature of Allied Electronics' 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 that insiders are buying to be useful.

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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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