Shareholders appeared unconcerned with Andhra Paper Limited's (NSE:ANDHRAPAP) lackluster earnings report last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.
Examining Cashflow Against Andhra Paper'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. 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. The ratio shows us how much a company's profit exceeds its FCF.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 2021, Andhra Paper had an accrual ratio of -0.14. That indicates that its free cash flow was a fair bit more than its statutory profit. In fact, it had free cash flow of ₹1.9b in the last year, which was a lot more than its statutory profit of ₹814.2m. Andhra Paper's free cash flow improved over the last year, which is generally good to see.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Andhra Paper.
Our Take On Andhra Paper's Profit Performance
Andhra Paper's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Andhra Paper's statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. 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. So while earnings quality is important, it's equally important to consider the risks facing Andhra Paper at this point in time. Every company has risks, and we've spotted 2 warning signs for Andhra Paper you should know about.
This note has only looked at a single factor that sheds light on the nature of Andhra Paper'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.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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