Richards Packaging Income Fund (TSE:RPI.UN) Is Growing Earnings But Are They A Good Guide?

Broadly speaking, profitable businesses are less risky than unprofitable ones. 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 Richards Packaging Income Fund (TSE:RPI.UN).

We like the fact that Richards Packaging Income Fund made a profit of CA$32.7m on its revenue of CA$444.0m, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years.

Check out our latest analysis for Richards Packaging Income Fund

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 Richards Packaging Income Fund'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 Richards Packaging Income Fund's 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). 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. 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.

For the year to September 2020, Richards Packaging Income Fund had an accrual ratio of -0.18. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of CA$66m in the last year, which was a lot more than its statutory profit of CA$32.7m. Richards Packaging Income Fund's free cash flow improved over the last year, which is generally good to see.

Our Take On Richards Packaging Income Fund's Profit Performance

As we discussed above, Richards Packaging Income Fund's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Richards Packaging Income Fund's statutory profit actually understates its earnings potential! And on top of that, 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. So while earnings quality is important, it's equally important to consider the risks facing Richards Packaging Income Fund at this point in time. You'd be interested to know, that we found 2 warning signs for Richards Packaging Income Fund and you'll want to know about them.

Today we've zoomed in on a single data point to better understand the nature of Richards Packaging Income Fund'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. 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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