Sree Rayalaseema Hi-Strength Hypo (NSE:SRHHYPOLTD) Is Growing Earnings But Are They A Good Guide?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding Sree Rayalaseema Hi-Strength Hypo (NSE:SRHHYPOLTD).

We like the fact that Sree Rayalaseema Hi-Strength Hypo made a profit of ₹516.3m on its revenue of ₹7.51b, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years.

View our latest analysis for Sree Rayalaseema Hi-Strength Hypo

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, we think it's well worth considering what Sree Rayalaseema Hi-Strength Hypo's 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 Sree Rayalaseema Hi-Strength Hypo.

A Closer Look At Sree Rayalaseema Hi-Strength Hypo'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.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Sree Rayalaseema Hi-Strength Hypo has an accrual ratio of -0.14 for the year to September 2020. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of ₹930m, well over the ₹516.3m it reported in profit. Sree Rayalaseema Hi-Strength Hypo shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Sree Rayalaseema Hi-Strength Hypo's Profit Performance

Sree Rayalaseema Hi-Strength Hypo's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Sree Rayalaseema Hi-Strength Hypo's statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. 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'd like to know more about Sree Rayalaseema Hi-Strength Hypo as a business, it's important to be aware of any risks it's facing. In terms of investment risks, we've identified 3 warning signs with Sree Rayalaseema Hi-Strength Hypo, and understanding these should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of Sree Rayalaseema Hi-Strength Hypo'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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