We Think That There Are Issues Underlying NCC's (NSE:NCC) Earnings

NCC Limited's (NSE:NCC) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

Check out our latest analysis for NCC

Examining Cashflow Against NCC'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. 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.

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. 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 March 2022, NCC had an accrual ratio of -0.10. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of ₹12b, well over the ₹4.82b it reported in profit. NCC's free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that NCC's profit was boosted by unusual items worth ₹2.0b in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. 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 NCC's Profit Performance

NCC'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. Based on these factors, we think it's very unlikely that NCC's statutory profits make it seem much weaker than it is. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 2 warning signs for NCC you should be aware of.

Our examination of NCC 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.