Statutory Earnings May Not Be The Best Way To Understand W.S. Industries (India)'s (NSE:WSI) True Position

W.S. Industries (India) Limited (NSE:WSI) recently released a strong earnings report, and the market responded by raising the share price. Despite the strong profit numbers, we believe that there are some deeper issues which investors should look into.

View our latest analysis for W.S. Industries (India)

Zooming In On W.S. Industries (India)'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 2023, W.S. Industries (India) had an accrual ratio of 1.33. 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. Even though it reported a profit of ₹209.0m, a look at free cash flow indicates it actually burnt through ₹958m in the last year. We also note that W.S. Industries (India)'s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹958m. Having said that, there is more to consider. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of W.S. Industries (India).

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, W.S. Industries (India) issued 52% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. Check out W.S. Industries (India)'s historical EPS growth by clicking on this link.

How Is Dilution Impacting W.S. Industries (India)'s Earnings Per Share (EPS)?

Three years ago, W.S. Industries (India) lost money. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). So you can see that the dilution has had a fairly significant impact on shareholders.

In the long term, if W.S. Industries (India)'s earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by ₹77m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. W.S. Industries (India) had a rather significant contribution from unusual items relative to its profit to September 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On W.S. Industries (India)'s Profit Performance

In conclusion, W.S. Industries (India)'s weak accrual ratio suggested its statutory earnings have been inflated by the unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. For all the reasons mentioned above, we think that, at a glance, W.S. Industries (India)'s statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. If you'd like to know more about W.S. Industries (India) as a business, it's important to be aware of any risks it's facing. To help with this, we've discovered 4 warning signs (3 are potentially serious!) that you ought to be aware of before buying any shares in W.S. Industries (India).

Our examination of W.S. Industries (India) has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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.

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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.