Investors Can Find Comfort In GMM Pfaudler's (NSE:GMMPFAUDLR) Earnings Quality

GMM Pfaudler Limited's (NSE:GMMPFAUDLR) earnings announcement last week didn't impress shareholders. While the headline numbers were soft, we believe that investors might be missing some encouraging factors.

Check out our latest analysis for GMM Pfaudler

Examining Cashflow Against GMM Pfaudler's 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2024, GMM Pfaudler had an accrual ratio of -0.18. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of ₹3.6b, well over the ₹1.02b it reported in profit. GMM Pfaudler's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of GMM Pfaudler.

Our Take On GMM Pfaudler's Profit Performance

Happily for shareholders, GMM Pfaudler produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that GMM Pfaudler's statutory profit actually understates its earnings potential! And the EPS is up 55% annually, over the last three years. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. In terms of investment risks, we've identified 1 warning sign with GMM Pfaudler, and understanding this should be part of your investment process.

This note has only looked at a single factor that sheds light on the nature of GMM Pfaudler's profit. 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.