Paramount Communications' (NSE:PARACABLES) Earnings Aren't As Good As They Appear

Paramount Communications Limited (NSE:PARACABLES) recently released a strong earnings report, and the market responded by raising the share price. However, we think that shareholders should be aware of some other factors beyond the profit numbers.

Check out our latest analysis for Paramount Communications

Zooming In On Paramount Communications' 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. 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".

Paramount Communications has an accrual ratio of 0.45 for the year to March 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of ₹1.5b, in contrast to the aforementioned profit of ₹856.3m. It's worth noting that Paramount Communications generated positive FCF of ₹21m a year ago, so at least they've done it in the past. 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 Paramount Communications.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Paramount Communications issued 56% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Paramount Communications' historical EPS growth by clicking on this link.

How Is Dilution Impacting Paramount Communications' Earnings Per Share (EPS)?

Paramount Communications has improved its profit over the last three years, with an annualized gain of 2,662% in that time. In comparison, earnings per share only gained 1,864% over the same period. And the 79% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 37% over the same period. So you can see that the dilution has had a fairly significant impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So Paramount Communications shareholders will want to see that EPS figure continue to increase. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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 Paramount Communications' Profit Performance

In conclusion, Paramount Communications has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. On reflection, the above-mentioned factors give us the strong impression that Paramount Communications'underlying earnings power is not as good as it might seem, based on the statutory profit numbers. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that Paramount Communications is showing 3 warning signs in our investment analysis and 2 of those don't sit too well with us...

Our examination of Paramount Communications has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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.