Even though MHM Automation Limited's (NZSE:MHM) recent earnings release was robust, the market didn't seem to notice. Investors are probably missing some underlying factors which are encouraging for the future of the company.
Zooming In On MHM Automation'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.
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. 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.
MHM Automation has an accrual ratio of -0.50 for the year to June 2021. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of NZ$4.8m during the period, dwarfing its reported profit of NZ$2.45m. MHM Automation's free cash flow improved over the last year, which is generally good to see.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of MHM Automation.
Our Take On MHM Automation's Profit Performance
Happily for shareholders, MHM Automation produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think MHM Automation's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Furthermore, it has done a great job growing EPS over the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. At Simply Wall St, we found 1 warning sign for MHM Automation and we think they deserve your attention.
Today we've zoomed in on a single data point to better understand the nature of MHM Automation'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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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