We Think Speciality Restaurants' (NSE:SPECIALITY) Robust Earnings Are Conservative

The subdued stock price reaction suggests that Speciality Restaurants Limited's (NSE:SPECIALITY) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

Check out the opportunities and risks within the IN Hospitality industry.

A Closer Look At Speciality Restaurants' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2022, Speciality Restaurants had an accrual ratio of -0.82. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of ₹803m during the period, dwarfing its reported profit of ₹402.3m. Speciality Restaurants' free cash flow improved over the last year, which is generally good to see. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that Speciality Restaurants' profit was boosted by unusual items worth ₹45m 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. If Speciality Restaurants doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Speciality Restaurants' Profit Performance

In conclusion, Speciality Restaurants' accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Considering all the aforementioned, we'd venture that Speciality Restaurants' profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. While it's very important to consider the profit and loss statement, you can also learn a lot about a company by looking at its balance sheet. You can see our latest analysis on Speciality Restaurants' balance sheet health here.

Our examination of Speciality Restaurants has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. 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.

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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.