Statutory Profit Doesn't Reflect How Good Somany Home Innovation's (NSE:SHIL) Earnings Are

Somany Home Innovation Limited (NSE:SHIL) just reported healthy earnings but the stock price didn't move much. Our analysis suggests that investors might be missing some promising details.

View our latest analysis for Somany Home Innovation

Examining Cashflow Against Somany Home Innovation's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 March 2021, Somany Home Innovation had an accrual ratio of -0.26. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of ₹2.1b during the period, dwarfing its reported profit of ₹548.4m. Somany Home Innovation shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Somany Home Innovation.

Our Take On Somany Home Innovation's Profit Performance

As we discussed above, Somany Home Innovation's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Somany Home Innovation's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! And on top of that, its earnings per share have grown at an extremely impressive rate over the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. Just as investors must consider earnings, it is also important to take into account the strength of a company's balance sheet. We've done some analysis and you can see our take on Somany Home Innovation's balance sheet by clicking here.

Today we've zoomed in on a single data point to better understand the nature of Somany Home Innovation's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. 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 that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. 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.
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