We Think Supreme Petrochem's (NSE:SUPPETRO) Statutory Profit Might Understate Its Earnings Potential

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. In this article, we'll look at how useful this year's statutory profit is, when analysing Supreme Petrochem (NSE:SUPPETRO).

While Supreme Petrochem was able to generate revenue of ₹22.7b in the last twelve months, we think its profit result of ₹998.5m was more important. In the last few years both its revenue and its profit have fallen, as you can see in the chart below.

See our latest analysis for Supreme Petrochem

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. As a result, we think it's well worth considering what Supreme Petrochem'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 Supreme Petrochem.

Zooming In On Supreme Petrochem'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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.

Supreme Petrochem has an accrual ratio of -0.55 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 ₹3.0b, well over the ₹998.5m it reported in profit. Supreme Petrochem shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Supreme Petrochem's Profit Performance

Happily for shareholders, Supreme Petrochem produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Supreme Petrochem's statutory profit actually understates its earnings potential! 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 Supreme Petrochem, you'd also look into what risks it is currently facing. To that end, you should learn about the 3 warning signs we've spotted with Supreme Petrochem (including 1 which is significant).

Today we've zoomed in on a single data point to better understand the nature of Supreme Petrochem's 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. 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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