Rama Phosphates' (NSE:RAMAPHO) Solid Profits Have Weak Fundamentals

Despite posting some strong earnings, the market for Rama Phosphates Limited's (NSE:RAMAPHO) stock hasn't moved much. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

View our latest analysis for Rama Phosphates

Examining Cashflow Against Rama Phosphates' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2022, Rama Phosphates recorded an accrual ratio of 0.39. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of ₹320m, in contrast to the aforementioned profit of ₹700.4m. It's worth noting that Rama Phosphates generated positive FCF of ₹254m a year ago, so at least they've done it in the past.

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

Our Take On Rama Phosphates' Profit Performance

As we discussed above, we think Rama Phosphates' earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Rama Phosphates' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the good news is that its EPS growth over the last three years has been very impressive. 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. So while earnings quality is important, it's equally important to consider the risks facing Rama Phosphates at this point in time. Case in point: We've spotted 4 warning signs for Rama Phosphates you should be mindful of and 2 of these bad boys make us uncomfortable.

Today we've zoomed in on a single data point to better understand the nature of Rama Phosphates' profit. 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.