There May Be Underlying Issues With The Quality Of 3M India's (NSE:3MINDIA) Earnings

Despite announcing strong earnings, 3M India Limited's (NSE:3MINDIA) stock was sluggish. We think that the market might be paying attention to some underlying factors that they find to be concerning.

View our latest analysis for 3M India

Examining Cashflow Against 3M India'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). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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. 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 September 2024, 3M India had an accrual ratio of 0.27. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. To wit, it produced free cash flow of ₹3.4b during the period, falling well short of its reported profit of ₹5.99b. 3M India's free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. The good news for shareholders is that 3M India's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On 3M India's Profit Performance

3M India's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that 3M India's true underlying earnings power is actually less than its statutory profit. But on the bright side, its earnings per share have grown at an extremely impressive rate 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that 3M India is showing 2 warning signs in our investment analysis and 1 of those is a bit concerning...

Today we've zoomed in on a single data point to better understand the nature of 3M India's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 with high insider ownership.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.