Are Orient Abrasives's (NSE:ORIENTABRA) Statutory Earnings A Good Reflection Of Its Earnings Potential?

Statistically speaking, it is less risky to invest in profitable companies than in 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. This article will consider whether Orient Abrasives' (NSE:ORIENTABRA) statutory profits are a good guide to its underlying earnings.

While Orient Abrasives was able to generate revenue of ₹3.06b in the last twelve months, we think its profit result of ₹134.3m was more important. 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.

Check out our latest analysis for Orient Abrasives

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 Orient Abrasives' 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 Orient Abrasives.

Zooming In On Orient Abrasives' 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. 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Orient Abrasives has an accrual ratio of -0.15 for the year to September 2020. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of ₹541m during the period, dwarfing its reported profit of ₹134.3m. Orient Abrasives' free cash flow improved over the last year, which is generally good to see.

Our Take On Orient Abrasives' Profit Performance

Orient Abrasives' accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Because of this, we think Orient Abrasives' 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 an extremely impressive rate 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. In terms of investment risks, we've identified 3 warning signs with Orient Abrasives, and understanding these bad boys should be part of your investment process.

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