Is There More To The Story Than IOL Chemicals and Pharmaceuticals's (NSE:IOLCP) Earnings Growth?

Broadly speaking, profitable businesses are less risky than 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 IOL Chemicals and Pharmaceuticals' (NSE:IOLCP) statutory profits are a good guide to its underlying earnings.

We like the fact that IOL Chemicals and Pharmaceuticals made a profit of ₹4.43b on its revenue of ₹19.5b, in the last year. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

View our latest analysis for IOL Chemicals and Pharmaceuticals

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. As a result, we think it's well worth considering what IOL Chemicals and Pharmaceuticals' 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 IOL Chemicals and Pharmaceuticals.

Zooming In On IOL Chemicals and Pharmaceuticals' 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. 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".

IOL Chemicals and Pharmaceuticals has an accrual ratio of 0.20 for the year to September 2020. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. To wit, it produced free cash flow of ₹2.9b during the period, falling well short of its reported profit of ₹4.43b. IOL Chemicals and Pharmaceuticals' free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. One positive for IOL Chemicals and Pharmaceuticals shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Our Take On IOL Chemicals and Pharmaceuticals' Profit Performance

IOL Chemicals and Pharmaceuticals' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that IOL Chemicals and Pharmaceuticals' true underlying earnings power is actually less than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To that end, you should learn about the 4 warning signs we've spotted with IOL Chemicals and Pharmaceuticals (including 1 which is significant).

Today we've zoomed in on a single data point to better understand the nature of IOL Chemicals and Pharmaceuticals' 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. 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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