Are Ampco-Pittsburgh's (NYSE:AP) Statutory Earnings A Good Guide To Its Underlying Profitability?

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. This article will consider whether Ampco-Pittsburgh's (NYSE:AP) statutory profits are a good guide to its underlying earnings.

We like the fact that Ampco-Pittsburgh made a profit of US$6.28m on its revenue of US$353.7m, in the last year. Even though revenue is down over the last three years, you can see in the chart below that the company has moved from loss-making to profitable.

See our latest analysis for Ampco-Pittsburgh

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll examine what Ampco-Pittsburgh's cashflow and its expanding share count tell us about the nature of its profits. 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.

Examining Cashflow Against Ampco-Pittsburgh's 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Ampco-Pittsburgh has an accrual ratio of -0.14 for the year to June 2020. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of US$23m, well over the US$6.28m it reported in profit. Given that Ampco-Pittsburgh had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$23m would seem to be a step in the right direction. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Ampco-Pittsburgh increased the number of shares on issue by 54% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. Check out Ampco-Pittsburgh's historical EPS growth by clicking on this link.

How Is Dilution Impacting Ampco-Pittsburgh's Earnings Per Share? (EPS)

Ampco-Pittsburgh was losing money three years ago. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). So you can see that the dilution has had a fairly significant impact on shareholders.

In the long term, if Ampco-Pittsburgh's earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Ampco-Pittsburgh's Profit Performance

In conclusion, Ampco-Pittsburgh has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Having considered these factors, we don't think Ampco-Pittsburgh's statutory profits give an overly harsh view of the business. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that Ampco-Pittsburgh is showing 4 warning signs in our investment analysis and 2 of those can't be ignored...

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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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