Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Nathan's Famous (NASDAQ:NATH).
While Nathan's Famous was able to generate revenue of US$82.6m in the last twelve months, we think its profit result of US$12.1m was more important. As depicted below, while its revenue may have fallen over the last few years, its profit actually improved.
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. So today we'll look at what Nathan's Famous' cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Nathan's Famous.
Examining Cashflow Against Nathan's Famous' Earnings
As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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.
Nathan's Famous has an accrual ratio of -0.86 for the year to September 2020. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of US$14m, well over the US$12.1m it reported in profit. Nathan's Famous' free cash flow improved over the last year, which is generally good to see.
Our Take On Nathan's Famous' Profit Performance
Happily for shareholders, Nathan's Famous produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Nathan's Famous' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And the EPS is up 66% annually, over the last three years. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. When we did our research, we found 2 warning signs for Nathan's Famous (1 can't be ignored!) that we believe deserve your full attention.
This note has only looked at a single factor that sheds light on the nature of Nathan's Famous' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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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