SRM Contractors' (NSE:SRM) Solid Profits Have Weak Fundamentals

SRM Contractors Limited (NSE:SRM) announced strong profits, but the stock was stagnant. We did some digging, and we found some concerning factors in the details.

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A Closer Look At SRM Contractors' 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). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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

Over the twelve months to March 2025, SRM Contractors recorded an accrual ratio of 0.64. 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. Even though it reported a profit of ₹550.0m, a look at free cash flow indicates it actually burnt through ₹453m in the last year. It's worth noting that SRM Contractors generated positive FCF of ₹50m 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 SRM Contractors.

Our Take On SRM Contractors' Profit Performance

As we discussed above, we think SRM Contractors' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that SRM Contractors' 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. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. In terms of investment risks, we've identified 2 warning signs with SRM Contractors, and understanding them should be part of your investment process.

Today we've zoomed in on a single data point to better understand the nature of SRM Contractors' 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. 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.