Here's Why Gulf Oil Lubricants India's (NSE:GULFOILLUB) Statutory Earnings Are Arguably Too Conservative

As a general rule, we think profitable companies are less risky than companies that lose money. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Gulf Oil Lubricants India (NSE:GULFOILLUB).

We like the fact that Gulf Oil Lubricants India made a profit of ₹1.68b on its revenue of ₹14.3b, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years, albeit not in the last year.

View our latest analysis for Gulf Oil Lubricants India

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Gulf Oil Lubricants India'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 Gulf Oil Lubricants India.

A Closer Look At Gulf Oil Lubricants India'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2020, Gulf Oil Lubricants India had an accrual ratio of -0.20. 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 ₹2.7b in the last year, which was a lot more than its statutory profit of ₹1.68b. Gulf Oil Lubricants India shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Gulf Oil Lubricants India's Profit Performance

Happily for shareholders, Gulf Oil Lubricants India produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Gulf Oil Lubricants India's statutory profit actually understates its earnings potential! And the EPS is up 22% annually, over the last three years. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Gulf Oil Lubricants India.

Today we've zoomed in on a single data point to better understand the nature of Gulf Oil Lubricants India'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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