public stock company VSMPO-AVISMA's (MCX:VSMO) Conservative Accounting Might Explain Soft Earnings

Soft earnings didn't appear to concern public stock company VSMPO-AVISMA Corporation's (MCX:VSMO) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

See our latest analysis for public stock company VSMPO-AVISMA

Zooming In On public stock company VSMPO-AVISMA'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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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.

Over the twelve months to December 2020, public stock company VSMPO-AVISMA recorded an accrual ratio of -0.12. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of ₽34b during the period, dwarfing its reported profit of ₽6.57b. Given that public stock company VSMPO-AVISMA had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₽34b would seem to be a step in the right direction. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of public stock company VSMPO-AVISMA.

The Impact Of Unusual Items On Profit

Surprisingly, given public stock company VSMPO-AVISMA's accrual ratio implied strong cash conversion, its paper profit was actually boosted by ₽1.3b in unusual items. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On public stock company VSMPO-AVISMA's Profit Performance

In conclusion, public stock company VSMPO-AVISMA's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Given the contrasting considerations, we don't have a strong view as to whether public stock company VSMPO-AVISMA's profits are an apt reflection of its underlying potential for profit. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, public stock company VSMPO-AVISMA has 4 warning signs (and 1 which is a bit concerning) we think you should know about.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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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