Spectrum Electrical Industries' (NSE:SPECTRUM) Promising Earnings May Rest On Soft Foundations

Investors were disappointed with Spectrum Electrical Industries Limited's (NSE:SPECTRUM) earnings, despite the strong profit numbers. We did some digging and found some worrying underlying problems.

See our latest analysis for Spectrum Electrical Industries

Examining Cashflow Against Spectrum Electrical Industries' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Spectrum Electrical Industries has an accrual ratio of 0.35 for the year to September 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of ₹217.3m, a look at free cash flow indicates it actually burnt through ₹501m in the last year. It's worth noting that Spectrum Electrical Industries generated positive FCF of ₹89m a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Spectrum Electrical Industries.

Our Take On Spectrum Electrical Industries' Profit Performance

As we discussed above, we think Spectrum Electrical Industries' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Spectrum Electrical Industries' 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. 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. 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 instance, we've identified 2 warning signs for Spectrum Electrical Industries (1 can't be ignored) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Spectrum Electrical Industries' 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.