We Don’t Think Gallantt Ispat's (NSE:GALLANTT) Earnings Should Make Shareholders Too Comfortable

Gallantt Ispat Limited (NSE:GALLANTT) posted some decent earnings, but shareholders didn't react strongly. Our analysis has found some concerning factors which weaken the profit's foundation.

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Examining Cashflow Against Gallantt Ispat's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. 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.

Gallantt Ispat has an accrual ratio of 0.22 for the year to September 2022. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of ₹1.84b, a look at free cash flow indicates it actually burnt through ₹1.9b in the last year. We saw that FCF was ₹964m a year ago though, so Gallantt Ispat has at least been able to generate positive FCF in the past. 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 Gallantt Ispat.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Gallantt Ispat increased the number of shares on issue by 197% over the last twelve months by issuing new shares. As a result, its net income is now split between 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 Gallantt Ispat's historical EPS growth by clicking on this link.

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

As you can see above, Gallantt Ispat has been growing its net income over the last few years, with an annualized gain of 275% over three years. In comparison, earnings per share only gained 55% over the same period. And the 77% profit boost in the last year certainly seems impressive at first glance. But that's starkly different from the 11% drop in earnings per share. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

In the long term, if Gallantt Ispat's earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Gallantt Ispat's Profit Performance

As it turns out, Gallantt Ispat couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). Considering all this we'd argue Gallantt Ispat's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Gallantt Ispat at this point in time. To help with this, we've discovered 3 warning signs (2 are a bit unpleasant!) that you ought to be aware of before buying any shares in Gallantt Ispat.

Our examination of Gallantt Ispat 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.