Here's Why V.S.T. Tillers Tractors's (NSE:VSTTILLERS) Statutory Earnings Are Arguably Too Conservative

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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. This article will consider whether V.S.T. Tillers Tractors' (NSE:VSTTILLERS) statutory profits are a good guide to its underlying earnings.

While V.S.T. Tillers Tractors was able to generate revenue of ₹6.10b in the last twelve months, we think its profit result of ₹471.1m was more important. The chart below shows that both revenue and profit have declined over the last three years.

Check out our latest analysis for V.S.T. Tillers Tractors

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. As a result, today we're going to take a closer look at V.S.T. Tillers Tractors' cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of V.S.T. Tillers Tractors.

Examining Cashflow Against V.S.T. Tillers Tractors' 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 September 2020, V.S.T. Tillers Tractors had an accrual ratio of -0.38. 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 ₹1.9b in the last year, which was a lot more than its statutory profit of ₹471.1m. V.S.T. Tillers Tractors' free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

The Impact Of Unusual Items On Profit

V.S.T. Tillers Tractors' profit was reduced by unusual items worth ₹118m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect V.S.T. Tillers Tractors to produce a higher profit next year, all else being equal.

Our Take On V.S.T. Tillers Tractors' Profit Performance

Considering both V.S.T. Tillers Tractors' accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Based on these factors, we think V.S.T. Tillers Tractors' underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For instance, we've identified 2 warning signs for V.S.T. Tillers Tractors (1 makes us a bit uncomfortable) you should be familiar with.

Our examination of V.S.T. Tillers Tractors has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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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