Swaraj Suiting's (NSE:SWARAJ) Promising Earnings May Rest On Soft Foundations

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

View our latest analysis for Swaraj Suiting

A Closer Look At Swaraj Suiting's 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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 September 2024, Swaraj Suiting recorded an accrual ratio of 0.29. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. In the last twelve months it actually had negative free cash flow, with an outflow of ₹556m despite its profit of ₹228.6m, mentioned above. We also note that Swaraj Suiting's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹556m. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

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

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Swaraj Suiting issued 27% more new shares over the last year. 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 Swaraj Suiting's EPS by clicking here.

A Look At The Impact Of Swaraj Suiting's Dilution On Its Earnings Per Share (EPS)

Swaraj Suiting has improved its profit over the last three years, with an annualized gain of 536% in that time. In comparison, earnings per share only gained 276% over the same period. And the 141% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 80% over the same period. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Swaraj Suiting can grow EPS persistently. 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.

Our Take On Swaraj Suiting's Profit Performance

As it turns out, Swaraj Suiting couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. For the reasons mentioned above, we think that a perfunctory glance at Swaraj Suiting's statutory profits might make it look better than it really is on an underlying level. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 4 warning signs for Swaraj Suiting you should be mindful of and 2 of these are significant.

Our examination of Swaraj Suiting 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 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 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.