Does Payton Planar Magnetics's (EBR:PAY) Statutory Profit Adequately Reflect Its Underlying Profit?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Payton Planar Magnetics (EBR:PAY).

It's good to see that over the last twelve months Payton Planar Magnetics made a profit of US$8.89m on revenue of US$40.2m. Happily, it has grown both its profit and revenue over the last three years (though we note its profit is down over the last year).

Check out our latest analysis for Payton Planar Magnetics

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Payton Planar Magnetics' 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 Payton Planar Magnetics.

Examining Cashflow Against Payton Planar Magnetics' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Payton Planar Magnetics has an accrual ratio of -0.13 for the year to September 2020. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of US$11m, well over the US$8.89m it reported in profit. Payton Planar Magnetics' free cash flow improved over the last year, which is generally good to see.

Our Take On Payton Planar Magnetics' Profit Performance

As we discussed above, Payton Planar Magnetics has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Payton Planar Magnetics' statutory profit actually understates its earnings potential! And on top of that, its earnings per share have grown at 64% per year over the last three years. 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. While earnings are important, another area to consider is the balance sheet. We've done some analysis and you can see our take on Payton Planar Magnetics' balance sheet by clicking here.

This note has only looked at a single factor that sheds light on the nature of Payton Planar Magnetics' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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