Should You Rely On Tata Metaliks's (NSE:TATAMETALI) Earnings Growth?

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Tata Metaliks (NSE:TATAMETALI).

We like the fact that Tata Metaliks made a profit of ₹1.93b on its revenue of ₹17.7b, in the last year. Happily, it has grown both its profit and revenue over the last three years (though we note its revenue is down over the last year).

Check out our latest analysis for Tata Metaliks

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what Tata Metaliks' cashflow tells us about its earnings, as well as examining how issuing shares is impacting shareholder value. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Tata Metaliks.

Zooming In On Tata Metaliks' 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2020, Tata Metaliks had an accrual ratio of 0.20. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In fact, it had free cash flow of ₹100m in the last year, which was a lot less than its statutory profit of ₹1.93b. We note, however, that Tata Metaliks grew its free cash flow over the last year. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Tata Metaliks increased the number of shares on issue by 12% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. 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. You can see a chart of Tata Metaliks' EPS by clicking here.

How Is Dilution Impacting Tata Metaliks' Earnings Per Share? (EPS)

Tata Metaliks has improved its profit over the last three years, with an annualized gain of 55% in that time. In comparison, earnings per share only gained 39% over the same period. And the 31% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 24% over the same period. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Tata Metaliks shareholders will want to see that EPS figure continue to increase. 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 Tata Metaliks' Profit Performance

As it turns out, Tata Metaliks couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue Tata Metaliks' profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 2 warning signs for Tata Metaliks (of which 1 is a bit unpleasant!) you should know about.

Our examination of Tata Metaliks has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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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