Are Advance NanoTek's (ASX:ANO) Statutory Earnings A Good Guide To Its Underlying Profitability?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Advance NanoTek (ASX:ANO).

We like the fact that Advance NanoTek made a profit of AU$2.19m on its revenue of AU$12.3m, in the last year. Happily, it has grown both its profit and revenue over the last three years (but not in the last year), as you can see in the chart below.

Check out our latest analysis for Advance NanoTek

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. So today we'll look at what Advance NanoTek'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 Advance NanoTek.

Examining Cashflow Against Advance NanoTek'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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 December 2020, Advance NanoTek recorded an accrual ratio of 0.22. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of AU$3.3m, in contrast to the aforementioned profit of AU$2.19m. We also note that Advance NanoTek's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of AU$3.3m.

Our Take On Advance NanoTek's Profit Performance

Advance NanoTek didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Advance NanoTek's true underlying earnings power is actually less than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate 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'd like to know more about Advance NanoTek as a business, it's important to be aware of any risks it's facing. To help with this, we've discovered 3 warning signs (1 shouldn't be ignored!) that you ought to be aware of before buying any shares in Advance NanoTek.

Today we've zoomed in on a single data point to better understand the nature of Advance NanoTek'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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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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