We Think Lloyds Engineering Works' (NSE:LLOYDSENGG) Profit Is Only A Baseline For What They Can Achieve

The subdued stock price reaction suggests that Lloyds Engineering Works Limited's (NSE:LLOYDSENGG) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

Check out our latest analysis for Lloyds Engineering Works

A Closer Look At Lloyds Engineering Works' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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. 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 September 2024, Lloyds Engineering Works had an accrual ratio of -0.34. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of ₹2.0b in the last year, which was a lot more than its statutory profit of ₹973.8m. Notably, Lloyds Engineering Works had negative free cash flow last year, so the ₹2.0b it produced this year was a welcome improvement. Unfortunately for shareholders, the company has also been issuing new shares, diluting 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 Lloyds Engineering Works.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Lloyds Engineering Works increased the number of shares on issue by 7.7% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. 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 Lloyds Engineering Works' historical EPS growth by clicking on this link.

How Is Dilution Impacting Lloyds Engineering Works' Earnings Per Share (EPS)?

As you can see above, Lloyds Engineering Works has been growing its net income over the last few years, with an annualized gain of 16,657% over three years. In comparison, earnings per share only gained 14,098% over the same period. And at a glance the 92% gain in profit over the last year impresses. But in comparison, EPS only increased by 73% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Lloyds Engineering Works shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Lloyds Engineering Works' Profit Performance

In conclusion, Lloyds Engineering Works 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, we think that Lloyds Engineering Works' profits are a reasonably conservative guide to its underlying profitability. If you'd like to know more about Lloyds Engineering Works as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 1 warning sign for Lloyds Engineering Works you should be aware of.

Our examination of Lloyds Engineering Works 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.