Here's Why We Think Lachish Industries's (TLV:LHIS) Statutory Earnings Might Be Conservative

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. This article will consider whether Lachish Industries' (TLV:LHIS) statutory profits are a good guide to its underlying earnings.

We like the fact that Lachish Industries made a profit of ₪4.70m on its revenue of ₪116.8m, 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.

See our latest analysis for Lachish Industries

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. Today, we'll discuss Lachish Industries' free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Lachish Industries.

A Closer Look At Lachish Industries' 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. 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. 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.

Over the twelve months to June 2020, Lachish Industries recorded an accrual ratio of -0.34. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of ₪15m in the last year, which was a lot more than its statutory profit of ₪4.70m. Given that Lachish Industries had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₪15m would seem to be a step in the right direction.

Our Take On Lachish Industries' Profit Performance

As we discussed above, Lachish Industries' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Lachish Industries' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 24% over the last twelve months. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example - Lachish Industries has 2 warning signs we think you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Lachish Industries' 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. 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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