Some Investors May Be Willing To Look Past Kirloskar Electric's (NSE:KECL) Soft Earnings

Investors were disappointed with the weak earnings posted by Kirloskar Electric Company Limited (NSE:KECL ). While the headline numbers were soft, we believe that investors might be missing some encouraging factors.

Check out our latest analysis for Kirloskar Electric

A Closer Look At Kirloskar Electric'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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Kirloskar Electric has an accrual ratio of -0.11 for the year to September 2024. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of ₹367m during the period, dwarfing its reported profit of ₹139.5m. Kirloskar Electric's free cash flow improved over the last year, which is generally good to see. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

How Do Unusual Items Influence Profit?

Surprisingly, given Kirloskar Electric's accrual ratio implied strong cash conversion, its paper profit was actually boosted by ₹22m in unusual items. 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. Which is hardly surprising, given the name. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Kirloskar Electric's Profit Performance

Kirloskar Electric's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Given the contrasting considerations, we don't have a strong view as to whether Kirloskar Electric's profits are an apt reflection of its underlying potential for profit. If you'd like to know more about Kirloskar Electric as a business, it's important to be aware of any risks it's facing. For example, Kirloskar Electric has 2 warning signs (and 1 which can't be ignored) we think you should know about.

Our examination of Kirloskar Electric 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. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.