We Think That There Are Issues Underlying Cummins India's (NSE:CUMMINSIND) Earnings

Cummins India Limited's (NSE:CUMMINSIND) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for Cummins India

Zooming In On Cummins 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). 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 2024, Cummins India recorded an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In fact, it had free cash flow of ₹10b in the last year, which was a lot less than its statutory profit of ₹19.5b. We note, however, that Cummins India grew its free cash flow over the last year.

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 Cummins India's Profit Performance

Cummins India didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Cummins India's true underlying earnings power is actually less than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that Cummins India is showing 2 warning signs in our investment analysis and 1 of those is a bit unpleasant...

This note has only looked at a single factor that sheds light on the nature of Cummins 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.

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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.