Vesuvius India's (NSE:VESUVIUS) Conservative Accounting Might Explain Soft Earnings

Soft earnings didn't appear to concern Vesuvius India Limited's (NSE:VESUVIUS) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

Check out our latest analysis for Vesuvius India

Examining Cashflow Against Vesuvius India's 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. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

Vesuvius India has an accrual ratio of -0.11 for the year to December 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. To wit, it produced free cash flow of ₹869m during the period, dwarfing its reported profit of ₹530.5m. Vesuvius India's free cash flow improved over the last year, which is generally good to see.

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

Our Take On Vesuvius India's Profit Performance

Vesuvius India's accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Vesuvius India's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To that end, you should learn about the 2 warning signs we've spotted with Vesuvius India (including 1 which is significant).

This note has only looked at a single factor that sheds light on the nature of Vesuvius India'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.

If you’re looking to trade Vesuvius India, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.