Are Jullundur Motor Agency (Delhi)'s (NSE:JMA) Statutory Earnings A Good Guide To Its Underlying Profitability?

As a general rule, we think profitable companies are less risky than companies that lose money. 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 Jullundur Motor Agency (Delhi) (NSE:JMA).

We like the fact that Jullundur Motor Agency (Delhi) made a profit of ₹135.7m on its revenue of ₹3.32b, in the last year. The chart below shows how profit has actually increased over the last three years, even while revenue has declined.

See our latest analysis for Jullundur Motor Agency (Delhi)

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. So today we'll look at what Jullundur Motor Agency (Delhi)'s cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Jullundur Motor Agency (Delhi).

A Closer Look At Jullundur Motor Agency (Delhi)'s 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). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2020, Jullundur Motor Agency (Delhi) had an accrual ratio of -0.16. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of ₹289m during the period, dwarfing its reported profit of ₹135.7m. Jullundur Motor Agency (Delhi)'s free cash flow improved over the last year, which is generally good to see.

Our Take On Jullundur Motor Agency (Delhi)'s Profit Performance

As we discussed above, Jullundur Motor Agency (Delhi)'s accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Jullundur Motor Agency (Delhi)'s underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And it's also good to see that its earnings per share have improved a bit 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. While conducting our analysis, we found that Jullundur Motor Agency (Delhi) has 2 warning signs and it would be unwise to ignore these.

This note has only looked at a single factor that sheds light on the nature of Jullundur Motor Agency (Delhi)'s profit. But there are plenty of other ways to inform your opinion of a company. 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. 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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