We Think That There Are Some Issues For Coffee Holding (NASDAQ:JVA) Beyond Its Promising Earnings

The recent earnings posted by Coffee Holding Co., Inc. (NASDAQ:JVA) were solid, but the stock didn't move as much as we expected. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for Coffee Holding

Zooming In On Coffee Holding's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

Coffee Holding has an accrual ratio of -0.18 for the year to April 2021. 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$6.1m in the last year, which was a lot more than its statutory profit of US$1.04m. Coffee Holding's free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Coffee Holding.

The Impact Of Unusual Items On Profit

Surprisingly, given Coffee Holding's accrual ratio implied strong cash conversion, its paper profit was actually boosted by US$634k 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. We can see that Coffee Holding's positive unusual items were quite significant relative to its profit in the year to April 2021. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Coffee Holding's Profit Performance

Coffee Holding'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. Based on these factors, it's hard to tell if Coffee Holding's profits are a reasonable reflection of its underlying profitability. If you want to do dive deeper into Coffee Holding, you'd also look into what risks it is currently facing. Case in point: We've spotted 4 warning signs for Coffee Holding you should be mindful of and 1 of them shouldn't be ignored.

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