Concerns Surrounding Shanthi Gears' (NSE:SHANTIGEAR) Performance

Shanthi Gears Limited's (NSE:SHANTIGEAR) healthy profit numbers didn't contain any surprises for investors. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

See our latest analysis for Shanthi Gears

A Closer Look At Shanthi Gears' 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. The ratio shows us how much a company's profit exceeds its FCF.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Shanthi Gears has an accrual ratio of 0.26 for the year to March 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In fact, it had free cash flow of ₹163m in the last year, which was a lot less than its statutory profit of ₹822.5m. Shanthi Gears' free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits.

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.

Our Take On Shanthi Gears' Profit Performance

Shanthi Gears didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Shanthi Gears' true underlying earnings power is actually less than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing Shanthi Gears at this point in time. Be aware that Shanthi Gears is showing 2 warning signs in our investment analysis and 1 of those is significant...

Today we've zoomed in on a single data point to better understand the nature of Shanthi Gears' profit. 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.