Additional Considerations Required While Assessing Lokesh Machines' (NSE:LOKESHMACH) Strong Earnings

Last week's profit announcement from Lokesh Machines Limited (NSE:LOKESHMACH) was underwhelming for investors, despite headline numbers being robust. We did some digging and found some worrying underlying problems.

See our latest analysis for Lokesh Machines

Zooming In On Lokesh Machines' 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. 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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to March 2024, Lokesh Machines recorded an accrual ratio of 0.20. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of ₹138.5m, a look at free cash flow indicates it actually burnt through ₹417m in the last year. It's worth noting that Lokesh Machines generated positive FCF of ₹81m a year ago, so at least they've done it in the past.

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

Our Take On Lokesh Machines' Profit Performance

Lokesh Machines 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 Lokesh Machines' 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. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you want to do dive deeper into Lokesh Machines, you'd also look into what risks it is currently facing. Our analysis shows 4 warning signs for Lokesh Machines (2 are concerning!) and we strongly recommend you look at these before investing.

This note has only looked at a single factor that sheds light on the nature of Lokesh Machines' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.

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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.