Stock Analysis

We Think Everest Industries's (NSE:EVERESTIND) Statutory Profit Might Understate Its Earnings Potential

NSEI:EVERESTIND
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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 Everest Industries (NSE:EVERESTIND).

It's good to see that over the last twelve months Everest Industries made a profit of ₹343.6m on revenue of ₹11.6b. The chart below shows how profit has actually increased over the last three years, even while revenue has declined.

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NSEI:EVERESTIND Earnings and Revenue History December 17th 2020

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 Everest Industries' 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 Everest Industries.

A Closer Look At Everest Industries' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Everest Industries has an accrual ratio of -0.49 for the year to September 2020. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of ₹2.3b in the last year, which was a lot more than its statutory profit of ₹343.6m. Notably, Everest Industries had negative free cash flow last year, so the ₹2.3b it produced this year was a welcome improvement.

Our Take On Everest Industries' Profit Performance

Happily for shareholders, Everest Industries produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Everest Industries' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at 20% per year over the last three years. 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 want to do dive deeper into Everest Industries, you'd also look into what risks it is currently facing. For instance, we've identified 3 warning signs for Everest Industries (1 doesn't sit too well with us) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Everest 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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