Rama Steel Tubes' (NSE:RAMASTEEL) Earnings Are Weaker Than They Seem

Rama Steel Tubes Limited's (NSE:RAMASTEEL) 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.

View our latest analysis for Rama Steel Tubes

Examining Cashflow Against Rama Steel Tubes' 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to September 2021, Rama Steel Tubes had an accrual ratio of 0.28. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of ₹258m despite its profit of ₹250.3m, mentioned above. We saw that FCF was ₹164m a year ago though, so Rama Steel Tubes has at least been able to generate positive FCF in the past. One positive for Rama Steel Tubes 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. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

Our Take On Rama Steel Tubes' Profit Performance

Rama Steel Tubes' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Rama Steel Tubes' statutory profits are better than its underlying earnings power. 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 if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, Rama Steel Tubes has 3 warning signs (and 2 which are significant) we think you should know about.

This note has only looked at a single factor that sheds light on the nature of Rama Steel Tubes' 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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.

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