We're Not Counting On MDJM (NASDAQ:MDJH) To Sustain Its Statutory Profitability

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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. This article will consider whether MDJM's (NASDAQ:MDJH) statutory profits are a good guide to its underlying earnings.

We like the fact that MDJM made a profit of US$1.09m on its revenue of US$6.15m, in the last year. At the risk of seeming quaint, we do like to at least examine profit, even when a stock is improving revenue and considered a 'growth stock'.

View our latest analysis for MDJM

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. Today, we'll discuss MDJM's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of MDJM.

Examining Cashflow Against MDJM'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. 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. 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.

MDJM has an accrual ratio of 0.40 for the year to June 2020. That means it didn't generate anywhere near enough free cash flow to match its profit. As a general rule, that bodes poorly for future profitability. Indeed, in the last twelve months it reported free cash flow of US$313k, which is significantly less than its profit of US$1.09m. Notably, MDJM had negative free cash flow last year, so the US$313k it produced this year was a welcome improvement.

Our Take On MDJM's Profit Performance

As we discussed above, we think MDJM's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that MDJM's underlying earnings power is lower than its statutory profit. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing MDJM at this point in time. When we did our research, we found 4 warning signs for MDJM (2 are a bit concerning!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of MDJM's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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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