Sona Machinery's (NSE:SONAMAC) Shareholders May Want To Dig Deeper Than Statutory Profit

The market shrugged off Sona Machinery Limited's (NSE:SONAMAC) solid earnings report. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

View our latest analysis for Sona Machinery

A Closer Look At Sona Machinery'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. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2024, Sona Machinery had an accrual ratio of 1.08. Statistically speaking, that's a real negative for future earnings. 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 ₹288m, in contrast to the aforementioned profit of ₹102.2m. We saw that FCF was ₹26m a year ago though, so Sona Machinery has at least been able to generate positive FCF in the past.

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

Our Take On Sona Machinery's Profit Performance

As we discussed above, we think Sona Machinery's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Sona Machinery's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. 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. For example, Sona Machinery has 3 warning signs (and 2 which are concerning) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Sona Machinery's profit. 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. 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.