Some Investors May Be Willing To Look Past Axita Cotton's (NSE:AXITA) Soft Earnings

Axita Cotton Limited's (NSE:AXITA) earnings announcement last week didn't impress shareholders. However, our analysis suggests that the soft headline numbers are getting counterbalanced by some positive underlying factors.

See our latest analysis for Axita Cotton

Examining Cashflow Against Axita Cotton'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. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Axita Cotton has an accrual ratio of -0.27 for the year to September 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of ₹231m, well over the ₹119.6m it reported in profit. Axita Cotton 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 Axita Cotton.

Our Take On Axita Cotton's Profit Performance

Happily for shareholders, Axita Cotton produced plenty of free cash flow to back up its statutory profit numbers. Based on this observation, we consider it possible that Axita Cotton's statutory profit actually understates its earnings potential! And the EPS is up 63% annually, over the last three years. 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. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of Axita Cotton.

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