We Think Rocky Mountain Liquor's (CVE:RUM) Statutory Profit Might Understate Its Earnings Potential

As a general rule, we think profitable companies are less risky than companies that lose money. 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 Rocky Mountain Liquor (CVE:RUM).

We like the fact that Rocky Mountain Liquor made a profit of CA$1.35m on its revenue of CA$48.1m, in the last year. The good news is that the company managed to grow its revenue over the last three years, and also move from loss-making to profitable.

Check out our latest analysis for Rocky Mountain Liquor

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 Rocky Mountain Liquor's cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Rocky Mountain Liquor.

Examining Cashflow Against Rocky Mountain Liquor's 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2020, Rocky Mountain Liquor recorded an accrual ratio of -0.20. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CA$4.0m during the period, dwarfing its reported profit of CA$1.35m. Rocky Mountain Liquor shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Rocky Mountain Liquor's Profit Performance

As we discussed above, Rocky Mountain Liquor's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Rocky Mountain Liquor's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. When we did our research, we found 4 warning signs for Rocky Mountain Liquor (2 are a bit concerning!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Rocky Mountain Liquor's 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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