Are Federal-Mogul Goetze (India)'s (NSE:FMGOETZE) Statutory Earnings A Good Guide To Its Underlying Profitability?

As a general rule, we think profitable companies are less risky than companies that lose money. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding Federal-Mogul Goetze (India) (NSE:FMGOETZE).

It's good to see that over the last twelve months Federal-Mogul Goetze (India) made a profit of ₹325.0m on revenue of ₹10.9b. The chart below shows that both revenue and profit have declined over the last three years.

See our latest analysis for Federal-Mogul Goetze (India)

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, we think it's well worth considering what Federal-Mogul Goetze (India)'s cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Federal-Mogul Goetze (India).

Examining Cashflow Against Federal-Mogul Goetze (India)'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). 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Federal-Mogul Goetze (India) has an accrual ratio of -0.11 for the year to March 2020. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of ₹1.2b in the last year, which was a lot more than its statutory profit of ₹325.0m. Federal-Mogul Goetze (India) shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Federal-Mogul Goetze (India)'s Profit Performance

Federal-Mogul Goetze (India)'s accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Federal-Mogul Goetze (India)'s earnings potential is at least as good as it seems, and maybe even better! 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. If you'd like to know more about Federal-Mogul Goetze (India) as a business, it's important to be aware of any risks it's facing. You'd be interested to know, that we found 1 warning sign for Federal-Mogul Goetze (India) and you'll want to know about it.

Today we've zoomed in on a single data point to better understand the nature of Federal-Mogul Goetze (India)'s profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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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