Why Giriraj Civil Developers' (NSE:GIRIRAJ) Earnings Are Weaker Than They Seem

Strong earnings weren't enough to please Giriraj Civil Developers Limited's (NSE:GIRIRAJ) shareholders over the last week. We did some digging and found some underlying numbers that are worrying.

See our latest analysis for Giriraj Civil Developers

A Closer Look At Giriraj Civil Developers' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to March 2024, Giriraj Civil Developers had an accrual ratio of 0.45. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of ₹101.2m, a look at free cash flow indicates it actually burnt through ₹300m in the last year. We also note that Giriraj Civil Developers' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹300m. 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 Giriraj Civil Developers.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Giriraj Civil Developers expanded the number of shares on issue by 18% over the last year. As a result, its net income is now split between a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Giriraj Civil Developers' historical EPS growth by clicking on this link.

How Is Dilution Impacting Giriraj Civil Developers' Earnings Per Share (EPS)?

As you can see above, Giriraj Civil Developers has been growing its net income over the last few years, with an annualized gain of 279% over three years. In comparison, earnings per share only gained 157% over the same period. And the 125% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 58% over the same period. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Giriraj Civil Developers 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 Giriraj Civil Developers' Profit Performance

As it turns out, Giriraj Civil Developers couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue Giriraj Civil Developers' profits probably give an overly generous impression of its sustainable level of profitability. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. To help with this, we've discovered 3 warning signs (2 shouldn't be ignored!) that you ought to be aware of before buying any shares in Giriraj Civil Developers.

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 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.