Investors Shouldn't Be Too Comfortable With Graham's (NYSE:GHM) Earnings

Last week's profit announcement from Graham Corporation (NYSE:GHM) was underwhelming for investors, despite headline numbers being robust. Our analysis uncovered some concerning factors that we believe the market might be paying attention to.

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Examining Cashflow Against Graham's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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'.

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".

Graham has an accrual ratio of 0.26 for the year to September 2025. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of US$11m, in contrast to the aforementioned profit of US$13.7m. We saw that FCF was US$26m a year ago though, so Graham has at least been able to generate positive FCF in the past. The good news for shareholders is that Graham's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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.

Our Take On Graham's Profit Performance

Graham didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Graham's true underlying earnings power is actually less than its statutory profit. The good news is that, its earnings per share increased by 75% in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you want to do dive deeper into Graham, you'd also look into what risks it is currently facing. For example - Graham has 1 warning sign we think you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Graham's profit. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.