Hi-Tech Pipes' (NSE:HITECH) Shareholders Should Assess Earnings With Caution

Strong earnings weren't enough to please Hi-Tech Pipes Limited's (NSE:HITECH) shareholders over the last week. Our analysis found several concerning factors in the earnings report beyond the strong statutory profit number.

Check out our latest analysis for Hi-Tech Pipes

Examining Cashflow Against Hi-Tech Pipes' 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). 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. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Hi-Tech Pipes has an accrual ratio of 0.23 for the year to September 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In the last twelve months it actually had negative free cash flow, with an outflow of ₹1.5b despite its profit of ₹616.2m, mentioned above. We also note that Hi-Tech Pipes' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹1.5b. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Hi-Tech Pipes increased the number of shares on issue by 48% over the last twelve months by issuing new shares. That means its earnings are split among 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 Hi-Tech Pipes' historical EPS growth by clicking on this link.

A Look At The Impact Of Hi-Tech Pipes' Dilution On Its Earnings Per Share (EPS)

Hi-Tech Pipes has improved its profit over the last three years, with an annualized gain of 77% in that time. But EPS was only up 34% per year, in the exact same period. And the 30% profit boost in the last year certainly seems impressive at first glance. On the other hand, earnings per share are only up 8.4% in that time. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Hi-Tech Pipes can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Hi-Tech Pipes' Profit Performance

As it turns out, Hi-Tech Pipes couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. Considering all this we'd argue Hi-Tech Pipes' profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For example, we've found that Hi-Tech Pipes has 3 warning signs (2 don't sit too well with us!) that deserve your attention before going any further with your analysis.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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 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.