We Think That There Are More Issues For Diamines and Chemicals (NSE:DIAMINESQ) Than Just Sluggish Earnings

The market wasn't impressed with the soft earnings from Diamines and Chemicals Limited (NSE:DIAMINESQ) recently. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.

See our latest analysis for Diamines and Chemicals

Examining Cashflow Against Diamines and Chemicals' Earnings

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

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2023, Diamines and Chemicals recorded an accrual ratio of 0.53. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of ₹289.3m, a look at free cash flow indicates it actually burnt through ₹211m in the last year. We saw that FCF was ₹189m a year ago though, so Diamines and Chemicals has at least been able to generate positive FCF in the past.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Diamines and Chemicals.

Our Take On Diamines and Chemicals' Profit Performance

As we have made quite clear, we're a bit worried that Diamines and Chemicals didn't back up the last year's profit with free cashflow. For this reason, we think that Diamines and Chemicals' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Nonetheless, it's still worth noting that its earnings per share have grown at 15% over the last three years. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. To that end, you should learn about the 4 warning signs we've spotted with Diamines and Chemicals (including 1 which is a bit unpleasant).

This note has only looked at a single factor that sheds light on the nature of Diamines and Chemicals' profit. 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 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.