We Believe Annapurna Swadisht's (NSE:ANNAPURNA) Earnings Are A Poor Guide For Its Profitability

The latest earnings release from Annapurna Swadisht Limited (NSE:ANNAPURNA ) disappointed investors. Our analysis found several concerning factors in the earnings report beyond the strong statutory profit number.

See our latest analysis for Annapurna Swadisht

A Closer Look At Annapurna Swadisht's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to March 2024, Annapurna Swadisht had an accrual ratio of 0.68. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of ₹131.3m, a look at free cash flow indicates it actually burnt through ₹724m in the last year. We also note that Annapurna Swadisht's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹724m. 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 Annapurna Swadisht.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Annapurna Swadisht issued 11% more new shares over the last year. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of Annapurna Swadisht's EPS by clicking here.

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

Annapurna Swadisht has improved its profit over the last three years, with an annualized gain of 2,468% in that time. In comparison, earnings per share only gained 922% over the same period. And at a glance the 84% gain in profit over the last year impresses. But in comparison, EPS only increased by 71% over the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Annapurna Swadisht shareholders will want to see that EPS figure continue to increase. 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 Annapurna Swadisht's Profit Performance

As it turns out, Annapurna Swadisht 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 Annapurna Swadisht's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Annapurna Swadisht, you'd also look into what risks it is currently facing. For example, Annapurna Swadisht has 4 warning signs (and 2 which can't be ignored) we think you should know about.

Our examination of Annapurna Swadisht 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. 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.