Should You Use Bombay Burmah Trading Corporation's (NSE:BBTC) Statutory Earnings To Analyse It?

As a general rule, we think profitable companies are less risky than companies that lose money. 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 Bombay Burmah Trading Corporation's (NSE:BBTC) statutory profits are a good guide to its underlying earnings.

While Bombay Burmah Trading Corporation was able to generate revenue of ₹132.5b in the last twelve months, we think its profit result of ₹5.35b was more important. Happily, it has grown both its profit and revenue over the last three years (though we note its profit is down over the last year).

Check out our latest analysis for Bombay Burmah Trading Corporation

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. Today, we'll discuss Bombay Burmah Trading Corporation'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 Bombay Burmah Trading Corporation.

Zooming In On Bombay Burmah Trading Corporation's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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, Bombay Burmah Trading Corporation had an accrual ratio of -0.16. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of ₹17b in the last year, which was a lot more than its statutory profit of ₹5.35b. Bombay Burmah Trading Corporation's free cash flow improved over the last year, which is generally good to see.

Our Take On Bombay Burmah Trading Corporation's Profit Performance

As we discussed above, Bombay Burmah Trading Corporation has perfectly satisfactory free cash flow relative to profit. Because of this, we think Bombay Burmah Trading Corporation's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at 53% per year over the last three years. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 2 warning signs for Bombay Burmah Trading Corporation you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Bombay Burmah Trading Corporation'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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