Shareholders Shouldn’t Be Too Comfortable With A B Infrabuild's (NSE:ABINFRA) Strong Earnings

We didn't see A B Infrabuild Limited's (NSE:ABINFRA) stock surge when it reported robust earnings recently. We think that investors might be worried about the foundations the earnings are built on.

See our latest analysis for A B Infrabuild

Zooming In On A B Infrabuild's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2023, A B Infrabuild recorded an accrual ratio of 0.61. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of ₹318m, in contrast to the aforementioned profit of ₹138.1m. It's worth noting that A B Infrabuild generated positive FCF of ₹32m a year ago, so at least they've done it in the past. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of A B Infrabuild.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, A B Infrabuild issued 170% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out A B Infrabuild's historical EPS growth by clicking on this link.

How Is Dilution Impacting A B Infrabuild's Earnings Per Share (EPS)?

As it happens, we don't know how much the company made or lost three years ago, because we don't have the data. On the bright side, in the last twelve months it grew profit by 252%. On the other hand, earnings per share are only up 58% over the same period. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So A B Infrabuild shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On A B Infrabuild's Profit Performance

In conclusion, A B Infrabuild has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. For all the reasons mentioned above, we think that, at a glance, A B Infrabuild's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. So while earnings quality is important, it's equally important to consider the risks facing A B Infrabuild at this point in time. To help with this, we've discovered 4 warning signs (2 are potentially serious!) that you ought to be aware of before buying any shares in A B Infrabuild.

Our examination of A B Infrabuild 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 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 that insiders are buying.

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.