Kotyark Industries' (NSE:KOTYARK) Earnings Might Be Weaker Than You Think

Investors appear disappointed with Kotyark Industries Limited's (NSE:KOTYARK) recent earnings, despite the decent statutory profit number. Our analysis has found some underlying factors which may be cause for concern.

View our latest analysis for Kotyark Industries

A Closer Look At Kotyark Industries' 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. 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 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.

Kotyark Industries has an accrual ratio of 0.66 for the year to March 2024. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of ₹222.0m, a look at free cash flow indicates it actually burnt through ₹691m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹691m, this year, indicates high risk. Unfortunately for shareholders, the company has also been issuing new shares, diluting 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 Kotyark Industries.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Kotyark Industries expanded the number of shares on issue by 5.6% 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. Check out Kotyark Industries' historical EPS growth by clicking on this link.

How Is Dilution Impacting Kotyark Industries' Earnings Per Share (EPS)?

Kotyark Industries has improved its profit over the last three years, with an annualized gain of 2,026% in that time. In comparison, earnings per share only gained 530% over the same period. And the 94% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 69% over the same period. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Kotyark Industries 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 Kotyark Industries' Profit Performance

As it turns out, Kotyark Industries 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 Kotyark Industries' statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Kotyark Industries at this point in time. For instance, we've identified 5 warning signs for Kotyark Industries (3 make us uncomfortable) you should be familiar with.

Our examination of Kotyark Industries 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 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. 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.