Investors Shouldn't Be Too Comfortable With Ashok Leyland's (NSE:ASHOKLEY) Earnings

Ashok Leyland Limited's (NSE:ASHOKLEY) stock was strong after they recently reported robust earnings. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

Check out our latest analysis for Ashok Leyland

A Closer Look At Ashok Leyland'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. 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".

Ashok Leyland has an accrual ratio of 0.25 for the year to March 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of ₹74b, in contrast to the aforementioned profit of ₹24.8b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹74b, this year, indicates high risk.

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 Ashok Leyland's Profit Performance

Ashok Leyland 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 Ashok Leyland's statutory profits are better than its underlying earnings power. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about Ashok Leyland as a business, it's important to be aware of any risks it's facing. For instance, we've identified 3 warning signs for Ashok Leyland (2 are a bit unpleasant) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Ashok Leyland'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. 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.

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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.