Are Avadh Sugar & Energy's (NSE:AVADHSUGAR) Statutory Earnings A Good Guide To Its Underlying Profitability?

Broadly speaking, profitable businesses are less risky than unprofitable ones. 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 Avadh Sugar & Energy's (NSE:AVADHSUGAR) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Avadh Sugar & Energy made a profit of ₹852.5m on revenue of ₹28.3b. While it managed to grow its revenue over the last three years, its profit has moved in the other direction, as you can see in the chart below.

See our latest analysis for Avadh Sugar & Energy

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. Today, we'll discuss Avadh Sugar & Energy's 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 Avadh Sugar & Energy.

A Closer Look At Avadh Sugar & Energy's 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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. 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, Avadh Sugar & Energy had an accrual ratio of -0.13. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of ₹3.8b during the period, dwarfing its reported profit of ₹852.5m. Given that Avadh Sugar & Energy had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₹3.8b would seem to be a step in the right direction.

Our Take On Avadh Sugar & Energy's Profit Performance

As we discussed above, Avadh Sugar & Energy has perfectly satisfactory free cash flow relative to profit. Based on this observation, we consider it likely that Avadh Sugar & Energy's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Case in point: We've spotted 5 warning signs for Avadh Sugar & Energy you should be mindful of and 2 of these shouldn't be ignored.

This note has only looked at a single factor that sheds light on the nature of Avadh Sugar & Energy's 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. 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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