Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company’s underlying profitability. In this article, we’ll look at how useful this year’s statutory profit is, when analysing BEML (NSE:BEML).
While BEML was able to generate revenue of ₹35.5b in the last twelve months, we think its profit result of ₹837.0m was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years, although its profit has slipped in the last twelve months.
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. Today, we’ll discuss BEML’s free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of BEML.
Zooming In On BEML’s Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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’.
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 having an accrual ratio above zero is of little concern, we do think it’s worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
For the year to September 2019, BEML had an accrual ratio of -0.15. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of ₹4.5b, well over the ₹837.0m it reported in profit. BEML’s free cash flow improved over the last year, which is generally good to see.
Our Take On BEML’s Profit Performance
BEML’s accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think BEML’s earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at 12% per year over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company’s potential, but there is plenty more to consider. While it’s very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. If you want to,you can see our take on BEML’s balance sheet by clicking here.
This note has only looked at a single factor that sheds light on the nature of BEML’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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.