Thursday, December 1 2022

Although Ari Real Estate (Arena) Investment Ltd (TLV:ARIN) recently posted strong earnings, the stock did not react significantly. We think investors might be concerned about the foundations on which earnings are based.

See our latest analysis for Ari Real Estate (Arena) Investment

TASE: ARIN Earnings and Revenue History as of March 21, 2022

Review of Cash Flow vs Earnings of Ari Real Estate (Arena) Investment

A key financial ratio used to measure a company’s ability to convert earnings into free cash flow (FCF) is the exercise ratio. To get the strike ratio, we first subtract FCF from earnings for a period and then divide that number by the average operating assets for the period. You can think of the cash flow equalization ratio as the “non-FCF profit ratio”.

Therefore, it is actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While having a accrual ratio greater than zero is of little concern, we believe it is worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, “Companies with higher accrued liabilities tend to be less profitable in the future.”

For the year to December 2021, Ari Real Estate (Arena) Investment had an accrual ratio of 0.23. Therefore, we know that his free cash flow was significantly lower than his statutory profit, which is hardly a good thing. In fact, it had free cash flow of ₪8.8 million last year, which was well below its statutory profit of ₪193.8 million. The shareholders of Ari Real Estate (Arena) Investment are no doubt hoping that its free cash flow will rebound next year, when it had been falling for twelve months. That said, there is more to consider. We also need to consider the impact of unusual items on statutory profit (and therefore the accrual rate), as well as note the ramifications of the company issuing new shares. The good news for shareholders is that Ari Real Estate (Arena) Investment’s accrual ratio was much better last year, so this year’s poor reading could simply be a case of a short-term mismatch between profit and FCF. Shareholders should look for an improvement in cash flow over current year earnings, if that is indeed the case.

To note: we always recommend that investors check the strength of the balance sheet. Click here to access our analysis of the balance sheet of Ari Real Estate (Arena) Investment.

To understand the value of a company’s earnings growth, it is imperative to consider any dilution of shareholder interests. Ari Real Estate (Arena) Investment has increased the number of shares issued by 53% over the past year. This means that its profits are distributed among a larger number of stocks. Talking about net profit, without noticing earnings per share, is being distracted by the big numbers while ignoring the small numbers that speak to per share assess. You can see a chart of Ari Real Estate (Arena) Investment’s EPS by clicking here.

What is the impact of dilution on earnings per share of Ari Real Estate (Arena) Investment? (EPS)

Ari Real Estate (Arena) Investment was losing money three years ago. On the positive side, over the last twelve months, its profits have increased by 1,586%. But EPS was less impressive, up just 1,562% during that time. So you see that the dilution had a pretty big impact on the shareholders.

In the long run, the benefits per share growth should drive stock price growth. So it will definitely be an advantage for shareholders if Ari Real Estate (Arena) Investment can increase EPS persistently. However, if its earnings increase while its earnings per share remain stable (or even decline), shareholders might not see much benefit. For this reason, one could argue that EPS is more important than long-term net income, assuming the goal is to gauge whether a company’s stock price can rise.

The impact of unusual items on earnings

Considering the strike ratio, it is not too surprising that Ari Real Estate (Arena) Investment’s profit was boosted by unusual items worth ₪235 million in the last twelve months. While it’s always nice to have higher profits, sometimes a large contribution from unusual items dampens our enthusiasm. We have analyzed the figures of most publicly traded companies around the world, and it is very common for unusual items to be unique in nature. Which is hardly surprising, given the name. We can see that Ari Real Estate (Arena) Investment’s positive unusual items were quite large relative to its earnings for the year to December 2021. All things being equal, this would likely result in some statutory earnings a poor guide to underlying earnings. Power.

Our view on the earnings performance of Ari Real Estate (Arena) Investment

Ari Real Estate (Arena) Investment didn’t support earnings with free cash flow, but that’s not too surprising given earnings were boosted by unusual items. Meanwhile, new shares issued mean that shareholders now own less of the company, unless they themselves contribute more cash. For all the reasons mentioned above, we believe that at first glance, Ari Real Estate (Arena) Investment’s statutory earnings could be considered low quality, as they are likely to give investors an overly positive impression of the company. With this in mind, we would not consider investing in a stock unless we have a thorough understanding of the risks. For example, we found 3 warning signs that you should take a look to get a better picture of Ari Real Estate (Arena) Investment.

Our Ari Real Estate (Arena) Investment review has focused on some factors that can make its earnings look better than they are. And, based on that, we’re somewhat skeptical. But there are many other ways to inform your opinion about a company. Some people consider a high return on equity to be a good sign of a quality company. Although it might take a bit of research on your behalf, you might find this free collection of companies offering a high return on equity, or this list of stocks that insiders buy to be useful.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.


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