Integra Essentia's (NSE:ESSENTIA) Earnings Quality Is Low

The recent earnings release from Integra Essentia Limited (NSE:ESSENTIA ) was disappointing to investors. We think that they may have more to worry about than just soft profit numbers.

Check out our latest analysis for Integra Essentia

Zooming In On Integra Essentia'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'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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.

Integra Essentia has an accrual ratio of 0.71 for the year to September 2024. 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. Even though it reported a profit of ₹93.7m, a look at free cash flow indicates it actually burnt through ₹928m in the last year. We saw that FCF was ₹47m a year ago though, so Integra Essentia has at least been able to generate positive FCF 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 Integra Essentia.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Integra Essentia increased the number of shares on issue by 17% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Integra Essentia's EPS by clicking here.

How Is Dilution Impacting Integra Essentia's Earnings Per Share (EPS)?

Integra Essentia was losing money three years ago. Even looking at the last year, profit was still down 26%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down -35% in the same period. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Integra Essentia can grow EPS persistently. 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 Integra Essentia's Profit Performance

In conclusion, Integra Essentia 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 the reasons mentioned above, we think that a perfunctory glance at Integra Essentia's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Integra Essentia, you'd also look into what risks it is currently facing. Case in point: We've spotted 5 warning signs for Integra Essentia you should be mindful of and 1 of these can't be ignored.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.