W.S. Industries (India) (NSE:WSI) Is Posting Healthy Earnings, But It Is Not All Good News

Investors were disappointed with W.S. Industries (India) Limited's (NSE:WSI) recent earnings release. We did some analysis and believe that they might be concerned about some weak underlying factors.

Check out our latest analysis for W.S. Industries (India)

Examining Cashflow Against W.S. Industries (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. The ratio shows us how much a company's profit exceeds its FCF.

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 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.

Over the twelve months to March 2024, W.S. Industries (India) recorded an accrual ratio of 0.41. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of ₹469.5m, a look at free cash flow indicates it actually burnt through ₹140m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹140m, this year, indicates high risk. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

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. In fact, W.S. Industries (India) increased the number of shares on issue by 27% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. 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)?

W.S. Industries (India) was losing money three years ago. On the bright side, in the last twelve months it grew profit by 2,077%. But EPS was less impressive, up only 1,371% in that time. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So W.S. Industries (India) shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

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

In conclusion, W.S. Industries (India) has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. Considering all this we'd argue W.S. Industries (India)'s profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 4 warning signs for W.S. Industries (India) (1 is concerning!) and we strongly recommend you look at them before investing.

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 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.