Here's Why We Don't Think Retractable Technologies's (NYSEMKT:RVP) Statutory Earnings Reflect Its Underlying Earnings Potential

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding Retractable Technologies (NYSEMKT:RVP).

We like the fact that Retractable Technologies made a profit of US$16.4m on its revenue of US$62.5m, in the last year. The good news is that the company managed to grow its revenue over the last three years, and also move from loss-making to profitable.

See our latest analysis for Retractable Technologies

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. As a result, we think it's well worth considering what Retractable Technologies' cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Retractable Technologies.

Examining Cashflow Against Retractable Technologies' 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'.

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. 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 September 2020, Retractable Technologies had an accrual ratio of 0.90. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of US$77k despite its profit of US$16.4m, mentioned above. We saw that FCF was US$162k a year ago though, so Retractable Technologies has at least been able to generate positive FCF in the past.

Our Take On Retractable Technologies' Profit Performance

As we have made quite clear, we're a bit worried that Retractable Technologies didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Retractable Technologies' underlying earnings power is lower than its statutory profit. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you want to do dive deeper into Retractable Technologies, you'd also look into what risks it is currently facing. For example, we've found that Retractable Technologies has 3 warning signs (1 doesn't sit too well with us!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of Retractable Technologies' 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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