Solid earnings may not tell the whole story for PrimeEnergy Resources (NASDAQ:PNRG)

Following the solid earnings report from Prime Energy Resources Corporation (NASDAQ:PNRG), the market reacted with shares rising. While the earnings numbers were good, our analysis has revealed some concerning factors that shareholders should be aware of.

Check out our latest analysis for PrimeEnergy Resources

Considering PrimeEnergy Resources’ cash flow versus earnings

Many investors have never heard of the Accrual ratio from cash flowbut it is actually a useful measure of how well a company’s profit is covered by free cash flow (FCF) during a given period. The accrual ratio subtracts FCF from profit for a given period and divides the result by the company’s average funds from operations during that period. You could think of the accrual ratio from cash flow as the “non-FCF profit ratio.”

This means that a negative accrual ratio is a good thing because it shows that the company is generating more free cash flow than its earnings would suggest. This is not to say that we should be concerned about a positive accrual ratio, but it is worth noting when the accrual ratio is quite high. To quote a 2014 paper by Lewellen and Resutek, “Companies with higher accruals tend to be less profitable in the future.”

For the year to June 2024, PrimeEnergy Resources had an accrual ratio of 0.28. We can therefore assume that its free cash flow was well below covering its statutory profit. That is, it generated free cash flow of US$2.8 million during that period, well below its reported profit of US$47.7 million. Notably, PrimeEnergy Resources had negative free cash flow last year, so the US$2.8 million it generated this year was a welcome improvement.

Note: We always recommend investors check balance sheet strength. Click here to access our balance sheet analysis of PrimeEnergy Resources.

Our assessment of PrimeEnergy Resources’ earnings development

PrimeEnergy Resources hasn’t converted much of its profit into free cash flow over the last year, which some investors might consider rather suboptimal. Therefore, it seems possible to us that PrimeEnergy Resources’ true underlying earnings power is actually less than its statutory profit. But the positive side is that its earnings per share have grown at an extremely impressive rate over the last three years. Of course, we’ve only scratched the surface when analyzing its profit; you could also consider margins, forecast growth and return on capital, among other things. So while the quality of profit is important, it’s equally important to consider the risks that PrimeEnergy Resources is currently facing. For example, we’ve identified: 2 warning signs for PrimeEnergy Resources (1 we don’t like so much) that you should know.

Today we’ve focused on a single data point to better understand the nature of PrimeEnergy Resources’ earnings. But there are many other ways to form an opinion about a company. For example, many people consider a high return on equity to indicate a favorable business situation, while others prefer to “follow the money” and look for stocks that insiders are buying. You might want to check this out. free Collection of companies with high return on equity or this list of stocks with high insider ownership.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.