Gulshan Polyols' (NSE:GULPOLY) Profits Appear To Have Quality Issues

Gulshan Polyols Limited's (NSE:GULPOLY) robust recent earnings didn't do much to move the stock. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

Check out our latest analysis for Gulshan Polyols

Examining Cashflow Against Gulshan Polyols' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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.

For the year to March 2022, Gulshan Polyols had an accrual ratio of 0.31. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Even though it reported a profit of ₹852.5m, a look at free cash flow indicates it actually burnt through ₹526m in the last year. We saw that FCF was ₹912m a year ago though, so Gulshan Polyols 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. One positive for Gulshan Polyols shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Gulshan Polyols increased the number of shares on issue by 11% 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 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 Gulshan Polyols' EPS by clicking here.

A Look At The Impact Of Gulshan Polyols' Dilution on Its Earnings Per Share (EPS).

Gulshan Polyols has improved its profit over the last three years, with an annualized gain of 298% in that time. But EPS was only up 259% per year, in the exact same period. And the 36% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 23% in that time. So you can see that the dilution has had a bit of an impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Gulshan Polyols 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 Gulshan Polyols' Profit Performance

In conclusion, Gulshan Polyols has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. For the reasons mentioned above, we think that a perfunctory glance at Gulshan Polyols' statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Gulshan Polyols, you'd also look into what risks it is currently facing. Our analysis shows 4 warning signs for Gulshan Polyols (1 is concerning!) and we strongly recommend you look at them before investing.

Our examination of Gulshan Polyols 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. 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. 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.