Selan Exploration Technology (NSE:SELAN) Strong Profits May Be Masking Some Underlying Issues

Selan Exploration Technology Limited (NSE:SELAN) just released a solid earnings report, and the stock displayed some strength. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

Check out our latest analysis for Selan Exploration Technology

Examining Cashflow Against Selan Exploration Technology'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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 March 2024, Selan Exploration Technology recorded an accrual ratio of 0.53. 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. Even though it reported a profit of ₹327.4m, a look at free cash flow indicates it actually burnt through ₹870m in the last year. It's worth noting that Selan Exploration Technology generated positive FCF of ₹277m a year ago, so at least they've done it in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Selan Exploration Technology.

Our Take On Selan Exploration Technology's Profit Performance

As we have made quite clear, we're a bit worried that Selan Exploration Technology didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Selan Exploration Technology'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. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. If you'd like to know more about Selan Exploration Technology as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for Selan Exploration Technology (2 don't sit too well with us!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Selan Exploration Technology's profit. 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.