As a general rule, we think profitable companies are less risky than companies that lose money. 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. Today we’ll focus on whether this year’s statutory profits are a good guide to understanding Advanced Emissions Solutions (NASDAQ:ADES).
We like the fact that Advanced Emissions Solutions made a profit of US$19.2m on its revenue of US$63.0m, in the last year. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.
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 Advanced Emissions Solutions’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 Advanced Emissions Solutions.
Zooming In On Advanced Emissions Solutions’s Earnings
Many investors haven’t heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company’s profit is backed up by free cash flow (FCF) during a given period. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company’s profit exceeds its FCF.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, “firms with higher accruals tend to be less profitable in the future”.
Advanced Emissions Solutions has an accrual ratio of -0.20 for the year to March 2020. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of US$47m during the period, dwarfing its reported profit of US$19.2m. Advanced Emissions Solutions shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Our Take On Advanced Emissions Solutions’s Profit Performance
Happily for shareholders, Advanced Emissions Solutions produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Advanced Emissions Solutions’s underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the last year. 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 Advanced Emissions Solutions as a business, it’s important to be aware of any risks it’s facing. For example, we’ve discovered 4 warning signs that you should run your eye over to get a better picture of Advanced Emissions Solutions.
This note has only looked at a single factor that sheds light on the nature of Advanced Emissions Solutions’s profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to ‘follow the money’ and search out stocks that insiders are buying. 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. Thank you for reading.