It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. That said, the current statutory profit is not always a good guide to a company’s underlying profitability. This article will consider whether Sandesh’s (NSE:SANDESH) statutory profits are a good guide to its underlying earnings.
While Sandesh was able to generate revenue of ₹3.55b in the last twelve months, we think its profit result of ₹611.0m was more important. The chart below shows that both revenue and profit have declined over the last three years.
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 Sandesh’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 Sandesh.
Zooming In On Sandesh’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. 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.
Therefore, it’s actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While it’s not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. 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 March 2020, Sandesh recorded an accrual ratio of 0.30. Therefore, we know that it’s free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of ₹611.0m, a look at free cash flow indicates it actually burnt through ₹914.7m in the last year. We saw that FCF was ₹449m a year ago though, so Sandesh has at least been able to generate positive FCF in the past.
Our Take On Sandesh’s Profit Performance
Sandesh didn’t convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Sandesh’s statutory profits are better than its underlying earnings power. Sadly, its EPS was down over the last twelve months. 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 Sandesh at this point in time. Be aware that Sandesh is showing 3 warning signs in our investment analysis and 2 of those are a bit concerning…
This note has only looked at a single factor that sheds light on the nature of Sandesh’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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