Gokaldas Exports' (NSE:GOKEX) Problems Go Beyond Poor Profit

Shareholders didn't appear too concerned by Gokaldas Exports Limited's (NSE:GOKEX) weak earnings. We did some digging, and we believe that investors are missing some worrying factors underlying the profit figures.

Check out our latest analysis for Gokaldas Exports

Examining Cashflow Against Gokaldas Exports' 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Gokaldas Exports has an accrual ratio of 0.21 for the year to December 2023. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. To wit, it produced free cash flow of ₹112m during the period, falling well short of its reported profit of ₹1.34b. Gokaldas Exports shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. However, that's not the end of the story. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares. The good news for shareholders is that Gokaldas Exports' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Gokaldas Exports increased the number of shares on issue by 17% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Gokaldas Exports' EPS by clicking here.

A Look At The Impact Of Gokaldas Exports' Dilution On Its Earnings Per Share (EPS)

Gokaldas Exports has improved its profit over the last three years, with an annualized gain of 715% in that time. But EPS was only up 476% per year, in the exact same period. Net profit actually dropped by 28% in the last year. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 29%. So you can see that the dilution has had a bit of an impact on shareholders.

If Gokaldas Exports' EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. 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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Gokaldas Exports' profit was boosted by unusual items worth ₹161m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Gokaldas Exports' Profit Performance

Gokaldas Exports didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. The dilution means the results are weaker when viewed from a per-share perspective. For the reasons mentioned above, we think that a perfunctory glance at Gokaldas Exports' statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Gokaldas Exports at this point in time. For example, Gokaldas Exports has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Our examination of Gokaldas Exports 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 that insiders are buying.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.