Is There More To The Story Than Amrutanjan Health Care's (NSE:AMRUTANJAN) Earnings Growth?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Amrutanjan Health Care (NSE:AMRUTANJAN).

We like the fact that Amrutanjan Health Care made a profit of ₹473.6m on its revenue of ₹2.81b, in the last year. One positive is that it has grown both its profit and its revenue, over the last few years.

Check out our latest analysis for Amrutanjan Health Care

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 Amrutanjan Health Care'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 Amrutanjan Health Care.

Zooming In On Amrutanjan Health Care'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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

Over the twelve months to September 2020, Amrutanjan Health Care recorded an accrual ratio of -0.47. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of ₹744m in the last year, which was a lot more than its statutory profit of ₹473.6m. Amrutanjan Health Care shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Amrutanjan Health Care's Profit Performance

Happily for shareholders, Amrutanjan Health Care produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Amrutanjan Health Care's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Amrutanjan Health Care.

Today we've zoomed in on a single data point to better understand the nature of Amrutanjan Health Care'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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