We Think That There Are Issues Underlying Salona Cotspin's (NSE:SALONA) Earnings

Despite posting some strong earnings, the market for Salona Cotspin Limited's (NSE:SALONA) stock hasn't moved much. Our analysis suggests that shareholders have noticed something concerning in the numbers.

View our latest analysis for Salona Cotspin

Zooming In On Salona Cotspin's 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2021, Salona Cotspin recorded an accrual ratio of 0.83. 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. In the last twelve months it actually had negative free cash flow, with an outflow of ₹871m despite its profit of ₹165.7m, mentioned above. We also note that Salona Cotspin's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹871m.

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

Our Take On Salona Cotspin's Profit Performance

As we discussed above, we think Salona Cotspin's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Salona Cotspin's underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. 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. If you want to do dive deeper into Salona Cotspin, you'd also look into what risks it is currently facing. For example, Salona Cotspin has 4 warning signs (and 2 which don't sit too well with us) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Salona Cotspin's 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.

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.

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