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. Today we'll focus on whether this year's statutory profits are a good guide to understanding Chipotle Mexican Grill (NYSE:CMG).
We like the fact that Chipotle Mexican Grill made a profit of US$237.2m on its revenue of US$5.82b, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years, although its profit has slipped in the last twelve months.
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. So today we'll look at what Chipotle Mexican Grill's cashflow and unusual items tell us about the quality of its earnings. 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 Chipotle Mexican Grill'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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Over the twelve months to September 2020, Chipotle Mexican Grill recorded an accrual ratio of -0.19. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of US$393m in the last year, which was a lot more than its statutory profit of US$237.2m. Chipotle Mexican Grill shareholders are no doubt pleased that free cash flow improved over the last twelve months. 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.
How Do Unusual Items Influence Profit?
Chipotle Mexican Grill's profit was reduced by unusual items worth US$41m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. If Chipotle Mexican Grill 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 Chipotle Mexican Grill's Profit Performance
Considering both Chipotle Mexican Grill's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. Looking at all these factors, we'd say that Chipotle Mexican Grill's underlying earnings power is at least as good as the statutory numbers would make it seem. 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. At Simply Wall St, we have analyst estimates which you can view by clicking here.
Our examination of Chipotle Mexican Grill has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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. 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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