Does Atul Auto's (NSE:ATULAUTO) Statutory Profit Adequately Reflect Its Underlying Profit?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether Atul Auto's (NSE:ATULAUTO) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Atul Auto made a profit of ₹536.0m on revenue of ₹6.25b. One positive is that it has grown both its profit and its revenue, over the last few years, though not in the last twelve months.

See our latest analysis for Atul Auto

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 Atul Auto'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 Atul Auto.

Zooming In On Atul Auto'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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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 March 2020, Atul Auto had an accrual ratio of 0.26. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of ₹176.2m despite its profit of ₹536.0m, mentioned above. We also note that Atul Auto's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹176.2m.

Our Take On Atul Auto's Profit Performance

Atul Auto didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Atul Auto's true underlying earnings power is actually less than its statutory profit. Nonetheless, it's still worth noting that its earnings per share have grown at 46% over the last three years. 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 Atul Auto as a business, it's important to be aware of any risks it's facing. To that end, you should learn about the 3 warning signs we've spotted with Atul Auto (including 1 which doesn't sit too well with us).

This note has only looked at a single factor that sheds light on the nature of Atul Auto's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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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