Should You Use G N A Axles's (NSE:GNA) Statutory Earnings To Analyse It?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. In this article, we'll look at how useful this year's statutory profit is, when analysing G N A Axles (NSE:GNA).

We like the fact that G N A Axles made a profit of ₹286.2m on its revenue of ₹6.71b, in the last year. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

See our latest analysis for G N A Axles

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. Today, we'll discuss G N A Axles' 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 G N A Axles.

Zooming In On G N A Axles' 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. 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. 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. 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 2020, G N A Axles had an accrual ratio of -0.11. 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 ₹989m during the period, dwarfing its reported profit of ₹286.2m. Notably, G N A Axles had negative free cash flow last year, so the ₹989m it produced this year was a welcome improvement.

Our Take On G N A Axles' Profit Performance

As we discussed above, G N A Axles has perfectly satisfactory free cash flow relative to profit. Because of this, we think G N A Axles' earnings potential is at least as good as it seems, and maybe even better! Unfortunately, though, its earnings per share actually fell back over the last year. 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. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of G N A Axles.

This note has only looked at a single factor that sheds light on the nature of G N A Axles' 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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