Stock Analysis

Should You Use Austin Engineering's (ASX:ANG) Statutory Earnings To Analyse It?

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ASX:ANG
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Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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 Austin Engineering's (ASX:ANG) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Austin Engineering made a profit of AU$4.54m on revenue of AU$230.4m. The chart below shows that revenue has improved over the last three years, and, even better, the company has moved from unprofitable to profitable.

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earnings-and-revenue-history
ASX:ANG Earnings and Revenue History January 16th 2021

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. As a result, we think it's well worth considering what Austin Engineering's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Zooming In On Austin Engineering'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. 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.

Over the twelve months to June 2020, Austin Engineering recorded an accrual ratio of -0.16. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of AU$20m in the last year, which was a lot more than its statutory profit of AU$4.54m. Austin Engineering shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Austin Engineering's Profit Performance

Austin Engineering's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Austin Engineering's earnings potential is at least as good as it seems, and maybe even better! Furthermore, it has done a great job growing EPS over the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. While conducting our analysis, we found that Austin Engineering has 2 warning signs and it would be unwise to ignore these.

Today we've zoomed in on a single data point to better understand the nature of Austin Engineering'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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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