Should You Use Swaraj Engines's (NSE:SWARAJENG) Statutory Earnings To Analyse It?

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 Swaraj Engines's (NSE:SWARAJENG) statutory profits are a good guide to its underlying earnings.

We like the fact that Swaraj Engines made a profit of ₹710.4m on its revenue of ₹7.73b, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years, albeit not in the last year.

View our latest analysis for Swaraj Engines

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. As a result, we think it's well worth considering what Swaraj Engines' 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 Swaraj Engines.

Zooming In On Swaraj Engines' 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. 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. 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 March 2020, Swaraj Engines had an accrual ratio of -0.11. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of ₹838m in the last year, which was a lot more than its statutory profit of ₹710.4m. Swaraj Engines' free cash flow improved over the last year, which is generally good to see.

Our Take On Swaraj Engines's Profit Performance

As we discussed above, Swaraj Engines has perfectly satisfactory free cash flow relative to profit. Because of this, we think Swaraj Engines's earnings potential is at least as good as it seems, and maybe even better! And on top of that, its earnings per share have grown at 5.6% per year over the last three years. 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. So while earnings quality is important, it's equally important to consider the risks facing Swaraj Engines at this point in time. At Simply Wall St, we found 2 warning signs for Swaraj Engines and we think they deserve your attention.

This note has only looked at a single factor that sheds light on the nature of Swaraj Engines' profit. 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. 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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