Investors Shouldn't Be Too Comfortable With Mallcom (India)'s (NSE:MALLCOM) Earnings

Last week's profit announcement from Mallcom (India) Limited (NSE:MALLCOM) was underwhelming for investors, despite headline numbers being robust. We did some digging and found some worrying underlying problems.

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Zooming In On Mallcom (India)'s Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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

Mallcom (India) has an accrual ratio of 0.40 for the year to March 2025. 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 ₹574.3m, a look at free cash flow indicates it actually burnt through ₹770m in the last year. We also note that Mallcom (India)'s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹770m.

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

Our Take On Mallcom (India)'s Profit Performance

As we have made quite clear, we're a bit worried that Mallcom (India) didn't back up the last year's profit with free cashflow. For this reason, we think that Mallcom (India)'s 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. So while earnings quality is important, it's equally important to consider the risks facing Mallcom (India) at this point in time. Be aware that Mallcom (India) is showing 2 warning signs in our investment analysis and 1 of those is a bit concerning...

This note has only looked at a single factor that sheds light on the nature of Mallcom (India)'s profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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.