Is There More To The Story Than GE Power India's (NSE:GEPIL) Earnings Growth?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether GE Power India's (NSE:GEPIL) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months GE Power India made a profit of ₹1.35b on revenue of ₹28.2b. In the chart below, you can see that its profit and revenue have both grown over the last three years.

View our latest analysis for GE Power India

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. So today we'll look at what GE Power India's cashflow and unusual items tell us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of GE Power India.

A Closer Look At GE Power India'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. 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. 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 2020, GE Power India recorded an accrual ratio of 1.46. 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. In the last twelve months it actually had negative free cash flow, with an outflow of ₹7.2b despite its profit of ₹1.35b, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹7.2b, this year, indicates high risk. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by ₹1.0b, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. We can see that GE Power India's positive unusual items were quite significant relative to its profit in the year to September 2020. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On GE Power India's Profit Performance

Summing up, GE Power India received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. On reflection, the above-mentioned factors give us the strong impression that GE Power India'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. If you'd like to know more about GE Power India as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for GE Power India (1 can't be ignored!) that we believe deserve your full attention.

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 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.

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This article by Simply Wall St is general in nature. 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.
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