We Think You Should Be Aware Of Some Concerning Factors In Blue Star's (NSE:BLUESTARCO) Earnings

Blue Star Limited's (NSE:BLUESTARCO) healthy profit numbers didn't contain any surprises for investors. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for Blue Star

Zooming In On Blue Star'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

Blue Star has an accrual ratio of 0.31 for the year to March 2024. 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. In the last twelve months it actually had negative free cash flow, with an outflow of ₹1.5b despite its profit of ₹4.15b, mentioned above. We also note that Blue Star's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹1.5b. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Blue Star issued 6.7% more new shares over the last year. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Blue Star's historical EPS growth by clicking on this link.

A Look At The Impact Of Blue Star's Dilution On Its Earnings Per Share (EPS)

As you can see above, Blue Star has been growing its net income over the last few years, with an annualized gain of 314% over three years. But EPS was only up 299% per year, in the exact same period. And over the last 12 months, the company grew its profit by 3.6%. On the other hand, earnings per share are pretty much flat, over the last twelve months. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if Blue Star's earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Blue Star's Profit Performance

As it turns out, Blue Star couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). Considering all this we'd argue Blue Star's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Blue Star, you'd also look into what risks it is currently facing. For example, Blue Star has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

Our examination of Blue Star 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. 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. 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.