Chaman Metallics' (NSE:CMNL) Profits Appear To Have Quality Issues

Chaman Metallics Limited's (NSE:CMNL) robust recent earnings didn't do much to move the stock. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

View our latest analysis for Chaman Metallics

Examining Cashflow Against Chaman Metallics' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. 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 September 2023, Chaman Metallics recorded an accrual ratio of 0.85. 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. In the last twelve months it actually had negative free cash flow, with an outflow of ₹751m despite its profit of ₹192.4m, mentioned above. We also note that Chaman Metallics' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹751m.

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

Our Take On Chaman Metallics' Profit Performance

As we discussed above, we think Chaman Metallics' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Chaman Metallics' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But on the bright side, its earnings per share have grown at an extremely impressive rate 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. So while earnings quality is important, it's equally important to consider the risks facing Chaman Metallics at this point in time. Case in point: We've spotted 4 warning signs for Chaman Metallics you should be mindful of and 2 of them are a bit concerning.

Today we've zoomed in on a single data point to better understand the nature of Chaman Metallics' profit. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.