Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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. In this article, we’ll look at how useful this year’s statutory profit is, when analysing Alpha Pro Tech (NYSEMKT:APT).
We like the fact that Alpha Pro Tech made a profit of US$12.3m on its revenue of US$66.6m, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years.
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. Today, we’ll discuss Alpha Pro Tech’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 Alpha Pro Tech.
A Closer Look At Alpha Pro Tech’s Earnings
Many investors haven’t heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company’s profit is backed up by free cash flow (FCF) during a given period. 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. The ratio shows us how much a company’s profit exceeds its FCF.
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. 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 June 2020, Alpha Pro Tech recorded an accrual ratio of -0.24. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of US$18m, well over the US$12.3m it reported in profit. Alpha Pro Tech shareholders are no doubt pleased that free cash flow improved over the last twelve months.
Our Take On Alpha Pro Tech’s Profit Performance
As we discussed above, Alpha Pro Tech’s accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Alpha Pro Tech’s statutory profit actually understates its earnings potential! Better yet, its EPS are growing strongly, which is nice to see. At the end of the day, it’s essential to consider more than just the factors above, if you want to understand the company properly. If you’d like to know more about Alpha Pro Tech as a business, it’s important to be aware of any risks it’s facing. Case in point: We’ve spotted 2 warning signs for Alpha Pro Tech you should be aware of.
Today we’ve zoomed in on a single data point to better understand the nature of Alpha Pro Tech’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. 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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