Northwest Pipe's (NASDAQ:NWPX) Earnings Are Growing But Is There More To The Story?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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 Northwest Pipe (NASDAQ:NWPX).

It's good to see that over the last twelve months Northwest Pipe made a profit of US$25.8m on revenue of US$288.8m. In the chart below, you can see that its profit and revenue have both grown over the last three years.

See our latest analysis for Northwest Pipe

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. Therefore, we think it's worth taking a closer look at Northwest Pipe'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 Northwest Pipe'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Northwest Pipe has an accrual ratio of -0.11 for the year to September 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of US$52m in the last year, which was a lot more than its statutory profit of US$25.8m. Northwest Pipe's free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

The Impact Of Unusual Items On Profit

Surprisingly, given Northwest Pipe's accrual ratio implied strong cash conversion, its paper profit was actually boosted by US$5.2m 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 analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. 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 Northwest Pipe's Profit Performance

Northwest Pipe's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Having considered these factors, we don't think Northwest Pipe's statutory profits give an overly harsh view of the business. While it's really important to consider how well a company's statutory earnings represent its true earnings power, it's also worth taking a look at what analysts are forecasting for the future. So feel free to check out our free graph representing analyst forecasts.

Our examination of Northwest Pipe has focussed on certain factors that can make its earnings look better than they are. 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. 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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