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. In this article, we'll look at how useful this year's statutory profit is, when analysing Procter & Gamble Hygiene and Health Care (NSE:PGHH).
It's good to see that over the last twelve months Procter & Gamble Hygiene and Health Care made a profit of ₹6.65b on revenue of ₹33.2b. One positive is that it has grown both its profit and its revenue, over the last few years.
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 Procter & Gamble Hygiene and Health Care's 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 Procter & Gamble Hygiene and Health Care.
Zooming In On Procter & Gamble Hygiene and Health Care's 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'.
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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Procter & Gamble Hygiene and Health Care has an accrual ratio of -1.01 for the year to December 2020. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of ₹8.1b, well over the ₹6.65b it reported in profit. Procter & Gamble Hygiene and Health Care's free cash flow improved over the last year, which is generally good to see.
Our Take On Procter & Gamble Hygiene and Health Care's Profit Performance
As we discussed above, Procter & Gamble Hygiene and Health Care's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Procter & Gamble Hygiene and Health Care's 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 57% 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'd like to know more about Procter & Gamble Hygiene and Health Care as a business, it's important to be aware of any risks it's facing. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Procter & Gamble Hygiene and Health Care.
This note has only looked at a single factor that sheds light on the nature of Procter & Gamble Hygiene and Health Care's 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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