It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 Escalade’s (NASDAQ:ESCA) statutory profits are a good guide to its underlying earnings.
It’s good to see that over the last twelve months Escalade made a profit of US$15.8m on revenue of US$213.6m. In the chart below, you can see that its profit and revenue have both grown over the last three years.
Importantly, statutory profits are not always the best tool for understanding a company’s true earnings power, so it’s well worth examining profits in a little more detail. So today we’ll look at what Escalade’s cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Escalade.
A Closer Look At Escalade’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. The ratio shows us how much a company’s profit exceeds its FCF.
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. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Escalade has an accrual ratio of -0.12 for the year to July 2020. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of US$31m during the period, dwarfing its reported profit of US$15.8m. Given that Escalade had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$31m would seem to be a step in the right direction.
Our Take On Escalade’s Profit Performance
Escalade’s accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Escalade’s statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 42% per year 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 want to do dive deeper into Escalade, you’d also look into what risks it is currently facing. For example, we’ve discovered 1 warning sign that you should run your eye over to get a better picture of Escalade.
This note has only looked at a single factor that sheds light on the nature of Escalade’s profit. But there are plenty of other ways to inform your opinion of a company. 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.
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