Konstelec Engineers' (NSE:KONSTELEC) Earnings Are Weaker Than They Seem

Last week's profit announcement from Konstelec Engineers Limited (NSE:KONSTELEC) was underwhelming for investors, despite headline numbers being robust. We think that the market might be paying attention to some underlying factors that they find to be concerning.

See our latest analysis for Konstelec Engineers

Examining Cashflow Against Konstelec Engineers' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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 September 2024, Konstelec Engineers had an accrual ratio of 0.31. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Even though it reported a profit of ₹97.3m, a look at free cash flow indicates it actually burnt through ₹259m in the last year. We also note that Konstelec Engineers' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹259m.

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

Our Take On Konstelec Engineers' Profit Performance

Konstelec Engineers didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Konstelec Engineers' statutory profits are better than its underlying earnings power. But the good news is that its EPS growth over the last three years has been very impressive. 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. So while earnings quality is important, it's equally important to consider the risks facing Konstelec Engineers at this point in time. Case in point: We've spotted 3 warning signs for Konstelec Engineers you should be mindful of and 2 of them can't be ignored.

This note has only looked at a single factor that sheds light on the nature of Konstelec Engineers' profit. 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.