Stock Analysis

Here's Why We Think Sturm Ruger's (NYSE:RGR) Statutory Earnings Might Be Conservative

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NYSE:RGR
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Broadly speaking, profitable businesses are less risky than 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Sturm Ruger (NYSE:RGR).

We like the fact that Sturm Ruger made a profit of US$34.6m on its revenue of US$420.1m, in the last year. Below, you can see that both its revenue and its profit have fallen over the last three years.

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earnings-and-revenue-history
NYSE:RGR Earnings and Revenue History July 13th 2020

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Today, we'll discuss Sturm Ruger's free cashflow relative to its earnings, and consider what that tells us about the company. 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.

A Closer Look At Sturm Ruger'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.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to March 2020, Sturm Ruger had an accrual ratio of -0.28. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of US$69m in the last year, which was a lot more than its statutory profit of US$34.6m. Sturm Ruger shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Sturm Ruger's Profit Performance

As we discussed above, Sturm Ruger's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Sturm Ruger's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in the last twelve months. 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. If you want to do dive deeper into Sturm Ruger, you'd also look into what risks it is currently facing. When we did our research, we found 3 warning signs for Sturm Ruger (1 is potentially serious!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Sturm Ruger's profit. 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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