Here's Why Motorcar Parts of America's (NASDAQ:MPAA) Statutory Earnings Are Arguably Too Conservative

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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. This article will consider whether Motorcar Parts of America's (NASDAQ:MPAA) statutory profits are a good guide to its underlying earnings.

While Motorcar Parts of America was able to generate revenue of US$526.4m in the last twelve months, we think its profit result of US$4.84m was more important.

Check out our latest analysis for Motorcar Parts of America

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. Therefore, we think it's worth taking a closer look at Motorcar Parts of America's cashflow, as well as examining the impact that unusual items have had on its reported profit. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Examining Cashflow Against Motorcar Parts of America'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Motorcar Parts of America has an accrual ratio of -0.16 for the year to September 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of US$71m during the period, dwarfing its reported profit of US$4.84m. Given that Motorcar Parts of America had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$71m would seem to be a step in the right direction. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

The Impact Of Unusual Items On Profit

Motorcar Parts of America's profit was reduced by unusual items worth US$3.1m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Motorcar Parts of America doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Motorcar Parts of America's Profit Performance

Considering both Motorcar Parts of America's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Based on these factors, we think Motorcar Parts of America's earnings potential is at least as good as it seems, and maybe even better! So while earnings quality is important, it's equally important to consider the risks facing Motorcar Parts of America at this point in time. Every company has risks, and we've spotted 4 warning signs for Motorcar Parts of America (of which 1 doesn't sit too well with us!) you should know about.

After our examination into the nature of Motorcar Parts of America's profit, we've come away optimistic for the company. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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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