Are Seshasayee Paper and Boards's (NSE:SESHAPAPER) Statutory Earnings A Good Reflection Of Its Earnings Potential?

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. In this article, we'll look at how useful this year's statutory profit is, when analysing Seshasayee Paper and Boards (NSE:SESHAPAPER).

While Seshasayee Paper and Boards was able to generate revenue of ₹8.95b in the last twelve months, we think its profit result of ₹1.32b was more important. As depicted below, while its revenue may have fallen over the last few years, its profit actually improved.

Check out our latest analysis for Seshasayee Paper and Boards

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, we think it's well worth considering what Seshasayee Paper and Boards' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Seshasayee Paper and Boards.

A Closer Look At Seshasayee Paper and Boards' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. The ratio shows us how much a company's profit exceeds its FCF.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2020, Seshasayee Paper and Boards recorded an accrual ratio of 0.22. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of ₹1.32b, a look at free cash flow indicates it actually burnt through ₹493m in the last year. We saw that FCF was ₹1.7b a year ago though, so Seshasayee Paper and Boards has at least been able to generate positive FCF in the past.

Our Take On Seshasayee Paper and Boards' Profit Performance

Seshasayee Paper and Boards didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Seshasayee Paper and Boards' statutory profits are better than its underlying earnings power. Sadly, its EPS was down over the last twelve months. 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. If you want to do dive deeper into Seshasayee Paper and Boards, you'd also look into what risks it is currently facing. For instance, we've identified 2 warning signs for Seshasayee Paper and Boards (1 doesn't sit too well with us) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Seshasayee Paper and Boards' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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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