As a general rule, we think profitable companies are less risky than companies that lose money. 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 Matachewan Consolidated Mines (CVE:MCM.A).
We like the fact that Matachewan Consolidated Mines made a profit of CA$1.56m on its revenue of CA$1.83m, in the last year.
Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, we think it's well worth considering what Matachewan Consolidated Mines' 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 Matachewan Consolidated Mines.
Examining Cashflow Against Matachewan Consolidated Mines' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
For the year to June 2020, Matachewan Consolidated Mines had an accrual ratio of 1.69. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. Indeed, in the last twelve months it reported free cash flow of CA$183k, which is significantly less than its profit of CA$1.56m. At this point we should mention that Matachewan Consolidated Mines did manage to increase its free cash flow in the last twelve months The good news for shareholders is that Matachewan Consolidated Mines' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.
Our Take On Matachewan Consolidated Mines' Profit Performance
As we discussed above, we think Matachewan Consolidated Mines' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Matachewan Consolidated Mines' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. On the bright side, the company showed enough improvement to book a profit this year, after losing money 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. If you'd like to know more about Matachewan Consolidated Mines as a business, it's important to be aware of any risks it's facing. To that end, you should learn about the 4 warning signs we've spotted with Matachewan Consolidated Mines (including 3 which can't be ignored).
This note has only looked at a single factor that sheds light on the nature of Matachewan Consolidated Mines' profit. But there are plenty of other ways to inform your opinion of a company. 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. 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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