We Think Ambika Cotton Mills' (NSE:AMBIKCO) Robust Earnings Are Conservative

The subdued stock price reaction suggests that Ambika Cotton Mills Limited's (NSE:AMBIKCO) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

Check out our latest analysis for Ambika Cotton Mills

Examining Cashflow Against Ambika Cotton Mills' 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). 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.

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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2022, Ambika Cotton Mills recorded an accrual ratio of -0.21. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of ₹2.9b during the period, dwarfing its reported profit of ₹1.80b. Ambika Cotton Mills shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Ambika Cotton Mills.

Our Take On Ambika Cotton Mills' Profit Performance

As we discussed above, Ambika Cotton Mills' accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Because of this, we think Ambika Cotton Mills' underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! Better yet, its EPS are growing strongly, which is nice to see. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 2 warning signs for Ambika Cotton Mills you should know about.

This note has only looked at a single factor that sheds light on the nature of Ambika Cotton Mills' profit. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.