Indian Hume Pipe (NSE:INDIANHUME) Strong Profits May Be Masking Some Underlying Issues

Following the solid earnings report from The Indian Hume Pipe Company Limited (NSE:INDIANHUME), the market responded by bidding up the stock price. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

See our latest analysis for Indian Hume Pipe

A Closer Look At Indian Hume Pipe'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. The ratio shows us how much a company's profit exceeds its FCF.

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.

For the year to March 2024, Indian Hume Pipe had an accrual ratio of -0.10. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. Indeed, in the last twelve months it reported free cash flow of ₹2.1b, well over the ₹776.3m it reported in profit. Indian Hume Pipe shareholders are no doubt pleased that free cash flow improved over the last twelve months. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Indian Hume Pipe expanded the number of shares on issue by 8.7% over the last year. 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 Indian Hume Pipe's EPS by clicking here.

How Is Dilution Impacting Indian Hume Pipe's Earnings Per Share (EPS)?

Indian Hume Pipe has improved its profit over the last three years, with an annualized gain of 85% in that time. But EPS was only up 73% per year, in the exact same period. And the 39% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 30% in that time. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Indian Hume Pipe shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Indian Hume Pipe's Profit Performance

In conclusion, Indian Hume Pipe has strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share growth is weaker than its profit growth. Based on these factors, it's hard to tell if Indian Hume Pipe's profits are a reasonable reflection of its underlying profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. When we did our research, we found 4 warning signs for Indian Hume Pipe (1 doesn't sit too well with us!) that we believe deserve your full attention.

Our examination of Indian Hume Pipe has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. 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.