Shakti Pumps (India)'s (NSE:SHAKTIPUMP) Attractive Earnings Are Not All Good News For Shareholders

Despite posting strong earnings, Shakti Pumps (India) Limited's (NSE:SHAKTIPUMP) stock didn't move much over the last week. We looked deeper into the numbers and found that shareholders might be concerned with some underlying weaknesses.

See our latest analysis for Shakti Pumps (India)

Zooming In On Shakti Pumps (India)'s Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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".

For the year to September 2024, Shakti Pumps (India) had an accrual ratio of 0.49. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of ₹277m, in contrast to the aforementioned profit of ₹3.29b. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹277m, 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 Shakti Pumps (India).

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Shakti Pumps (India) increased the number of shares on issue by 9.0% over the last twelve months by issuing new shares. 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 Shakti Pumps (India)'s historical EPS growth by clicking on this link.

How Is Dilution Impacting Shakti Pumps (India)'s Earnings Per Share (EPS)?

As you can see above, Shakti Pumps (India) has been growing its net income over the last few years, with an annualized gain of 287% over three years. But EPS was only up 269% per year, in the exact same period. And the 1,516% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 1,445% over the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Shakti Pumps (India) can grow EPS persistently. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. 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 Shakti Pumps (India)'s Profit Performance

In conclusion, Shakti Pumps (India) 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. For the reasons mentioned above, we think that a perfunctory glance at Shakti Pumps (India)'s statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Shakti Pumps (India) as a business, it's important to be aware of any risks it's facing. For example, Shakti Pumps (India) has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Our examination of Shakti Pumps (India) 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.