Kitex Garments' (NSE:KITEX) Sluggish Earnings Might Be Just The Beginning Of Its Problems

A lackluster earnings announcement from Kitex Garments Limited (NSE:KITEX) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

Check out our latest analysis for Kitex Garments

A Closer Look At Kitex Garments' 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.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Kitex Garments has an accrual ratio of 0.55 for the year to March 2024. 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 ₹563.3m, a look at free cash flow indicates it actually burnt through ₹6.6b in the last year. We also note that Kitex Garments' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹6.6b.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Kitex Garments.

Our Take On Kitex Garments' Profit Performance

As we discussed above, we think Kitex Garments' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Kitex Garments' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. In further bad news, its earnings per share decreased in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about Kitex Garments as a business, it's important to be aware of any risks it's facing. For instance, we've identified 4 warning signs for Kitex Garments (3 are potentially serious) you should be familiar with.

Today we've zoomed in on a single data point to better understand the nature of Kitex Garments' 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.

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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.