Vardhman Textiles' (NSE:VTL) Anemic Earnings Might Be Worse Than You Think

Vardhman Textiles Limited's (NSE:VTL) recent weak earnings report didn't cause a big stock movement. However, we believe that investors should be aware of some underlying factors which may be of concern.

View our latest analysis for Vardhman Textiles

Zooming In On Vardhman Textiles' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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.

Over the twelve months to March 2024, Vardhman Textiles recorded an accrual ratio of 0.20. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of ₹6.32b, a look at free cash flow indicates it actually burnt through ₹13b in the last year. It's worth noting that Vardhman Textiles generated positive FCF of ₹12b a year ago, so at least they've done it in the past. The good news for shareholders is that Vardhman Textiles' 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.

Our Take On Vardhman Textiles' Profit Performance

Vardhman Textiles didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Vardhman Textiles' statutory profits are better than its underlying earnings power. Nonetheless, it's still worth noting that its earnings per share have grown at 51% over the last three years. 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 Vardhman Textiles as a business, it's important to be aware of any risks it's facing. Our analysis shows 2 warning signs for Vardhman Textiles (1 shouldn't be ignored!) and we strongly recommend you look at these before investing.

Today we've zoomed in on a single data point to better understand the nature of Vardhman Textiles' 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.