Kalyani Steels' (NSE:KSL) Earnings Are Of Questionable Quality

Kalyani Steels Limited's (NSE:KSL) robust earnings report didn't manage to move the market for its stock. We did some digging, and we found some concerning factors in the details.

See our latest analysis for Kalyani Steels

Zooming In On Kalyani Steels' 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. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to March 2024, Kalyani Steels recorded an accrual ratio of 0.35. 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. Even though it reported a profit of ₹2.49b, a look at free cash flow indicates it actually burnt through ₹2.6b in the last year. We also note that Kalyani Steels' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹2.6b.

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

Our Take On Kalyani Steels' Profit Performance

As we discussed above, we think Kalyani Steels' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Kalyani Steels' underlying earnings power is lower than its statutory profit. Nonetheless, it's still worth noting that its earnings per share have grown at 31% over the last three years. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For instance, we've identified 3 warning signs for Kalyani Steels (1 is significant) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Kalyani Steels' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 with significant insider holdings 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.