We Think M M Forgings's (NSE:MMFL) Statutory Profit Might Understate Its Earnings Potential

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 M M Forgings (NSE:MMFL).

While M M Forgings was able to generate revenue of ₹5.98b in the last twelve months, we think its profit result of ₹116.1m was more important. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

Check out our latest analysis for M M Forgings

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 M M Forgings' 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 M M Forgings.

Zooming In On M M Forgings' 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. 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. 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. 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, M M Forgings had an accrual ratio of -0.22. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of ₹2.0b in the last year, which was a lot more than its statutory profit of ₹116.1m. Given that M M Forgings had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₹2.0b would seem to be a step in the right direction.

Our Take On M M Forgings' Profit Performance

Happily for shareholders, M M Forgings produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think M M Forgings' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Unfortunately, though, its earnings per share actually fell back over the last year. 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. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 5 warning signs for M M Forgings (of which 2 can't be ignored!) you should know about.

This note has only looked at a single factor that sheds light on the nature of M M Forgings' 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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