SML Isuzu's (NSE:SMLISUZU) Promising Earnings May Rest On Soft Foundations

Despite posting some strong earnings, the market for SML Isuzu Limited's (NSE:SMLISUZU) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.

View our latest analysis for SML Isuzu

A Closer Look At SML Isuzu's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, SML Isuzu recorded an accrual ratio of 0.37. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of ₹921m despite its profit of ₹1.08b, mentioned above. It's worth noting that SML Isuzu generated positive FCF of ₹488m a year ago, so at least they've done it in the past. The good news for shareholders is that SML Isuzu's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of SML Isuzu.

Our Take On SML Isuzu's Profit Performance

As we have made quite clear, we're a bit worried that SML Isuzu didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that SML Isuzu's underlying earnings power is lower than its statutory profit. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. 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. If you want to do dive deeper into SML Isuzu, you'd also look into what risks it is currently facing. When we did our research, we found 4 warning signs for SML Isuzu (2 can't be ignored!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of SML Isuzu's profit. But there are plenty of other ways to inform your opinion of a company. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.