We Believe Jai Balaji Industries' (NSE:JAIBALAJI) Earnings Are A Poor Guide For Its Profitability

Strong earnings weren't enough to please Jai Balaji Industries Limited's (NSE:JAIBALAJI) shareholders over the last week. We did some analysis and believe that they might be concerned about some weak underlying factors.

Check out our latest analysis for Jai Balaji Industries

Examining Cashflow Against Jai Balaji Industries' 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. 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

For the year to September 2024, Jai Balaji Industries had an accrual ratio of 0.31. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. In fact, it had free cash flow of ₹2.8b in the last year, which was a lot less than its statutory profit of ₹8.70b. Jai Balaji Industries' free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. However, that's not the end of the story. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Jai Balaji Industries.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Jai Balaji Industries increased the number of shares on issue by 14% over the last twelve months by issuing new shares. That means its earnings are split among a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Jai Balaji Industries' EPS by clicking here.

How Is Dilution Impacting Jai Balaji Industries' Earnings Per Share (EPS)?

As you can see above, Jai Balaji Industries has been growing its net income over the last few years, with an annualized gain of 1,281% over three years. But EPS was only up 802% per year, in the exact same period. And at a glance the 125% gain in profit over the last year impresses. On the other hand, earnings per share are only up 97% in that time. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if Jai Balaji Industries can grow EPS persistently. 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.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by ₹1.7b, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. If Jai Balaji Industries doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Jai Balaji Industries' Profit Performance

In conclusion, Jai Balaji Industries' weak accrual ratio suggested its statutory earnings have been inflated by the unusual items. The dilution means the results are weaker when viewed from a per-share perspective. For all the reasons mentioned above, we think that, at a glance, Jai Balaji Industries' statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To help with this, we've discovered 2 warning signs (1 is significant!) that you ought to be aware of before buying any shares in Jai Balaji Industries.

Our examination of Jai Balaji Industries 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. 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.