Pritika Auto Industries' (NSE:PRITIKAUTO) Earnings Quality Is Low

The recent earnings release from Pritika Auto Industries Limited (NSE:PRITIKAUTO ) was disappointing to investors. We think that they may have more to worry about than just soft profit numbers.

View our latest analysis for Pritika Auto Industries

Zooming In On Pritika Auto Industries' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2024, Pritika Auto Industries recorded an accrual ratio of 0.22. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of ₹543m, in contrast to the aforementioned profit of ₹125.7m. We also note that Pritika Auto Industries' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹543m. 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 Pritika Auto Industries.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. As it happens, Pritika Auto Industries issued 82% more new shares over the last year. As a result, its net income is now split between a greater number of shares. 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. You can see a chart of Pritika Auto Industries' EPS by clicking here.

How Is Dilution Impacting Pritika Auto Industries' Earnings Per Share (EPS)?

Pritika Auto Industries has improved its profit over the last three years, with an annualized gain of 114% in that time. In comparison, earnings per share only gained 78% over the same period. Net income was down 15% over the last twelve months. But the EPS result was even worse, with the company recording a decline of 29%. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

If Pritika Auto Industries' EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Pritika Auto Industries' Profit Performance

In conclusion, Pritika Auto Industries has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). For the reasons mentioned above, we think that a perfunctory glance at Pritika Auto Industries' statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Pritika Auto Industries, you'd also look into what risks it is currently facing. For example, Pritika Auto Industries has 4 warning signs (and 3 which make us uncomfortable) we think you should know about.

Our examination of Pritika Auto Industries 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. 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.