Robust Earnings May Not Tell The Whole Story For Shaily Engineering Plastics (NSE:SHAILY)

Shaily Engineering Plastics Limited (NSE:SHAILY) announced strong profits, but the stock was stagnant. Our analysis suggests that shareholders have noticed something concerning in the numbers.

See our latest analysis for Shaily Engineering Plastics

Zooming In On Shaily Engineering Plastics' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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. 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 March 2022, Shaily Engineering Plastics had an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of ₹655m, in contrast to the aforementioned profit of ₹352.7m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹655m, this year, indicates high risk. Notably, the company has issued new shares, thus diluting existing shareholders and reducing 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 Shaily Engineering Plastics.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Shaily Engineering Plastics expanded the number of shares on issue by 10% over the last year. Therefore, each share now receives a smaller portion of profit. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Shaily Engineering Plastics' EPS by clicking here.

A Look At The Impact Of Shaily Engineering Plastics' Dilution on Its Earnings Per Share (EPS).

Shaily Engineering Plastics has improved its profit over the last three years, with an annualized gain of 83% in that time. But EPS was only up 72% per year, in the exact same period. And at a glance the 60% gain in profit over the last year impresses. But in comparison, EPS only increased by 51% 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 Shaily Engineering Plastics 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 the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Shaily Engineering Plastics' Profit Performance

As it turns out, Shaily Engineering Plastics couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue Shaily Engineering Plastics' profits probably give an overly generous impression of its sustainable level of profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. When we did our research, we found 2 warning signs for Shaily Engineering Plastics (1 is a bit concerning!) that we believe deserve your full attention.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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 that insiders are buying.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.