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. Today we’ll focus on whether this year’s statutory profits are a good guide to understanding United-Guardian (NASDAQ:UG).
It’s good to see that over the last twelve months United-Guardian made a profit of US$4.44m on revenue of US$13.4m. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.
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. Today, we’ll discuss United-Guardian’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 United-Guardian.
Examining Cashflow Against United-Guardian’s Earnings
In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.
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 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.
United-Guardian has an accrual ratio of -0.28 for the year to June 2020. 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 US$4.9m, well over the US$4.44m it reported in profit. United-Guardian shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Our Take On United-Guardian’s Profit Performance
As we discussed above, United-Guardian’s accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think United-Guardian’s underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at 31% 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. So if you’d like to dive deeper into this stock, it’s crucial to consider any risks it’s facing. At Simply Wall St, we found 2 warning signs for United-Guardian and we think they deserve your attention.
Today we’ve zoomed in on a single data point to better understand the nature of United-Guardian’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. 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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