DEN Networks' (NSE:DEN) Weak Earnings Might Be Worse Than They Appear

Shareholders didn't appear too concerned by DEN Networks Limited's (NSE:DEN) weak earnings. Our analysis suggests that they may be missing some concerning details underlying the profit numbers.

View our latest analysis for DEN Networks

A Closer Look At DEN Networks' 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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, DEN Networks had 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 ₹111m, in contrast to the aforementioned profit of ₹1.85b. We saw that FCF was ₹800m a year ago though, so DEN Networks has at least been able to generate positive FCF in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by ₹1.3b, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that DEN Networks' positive unusual items were quite significant relative to its profit in the year to September 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On DEN Networks' Profit Performance

DEN Networks had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue DEN Networks' profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into DEN Networks, you'd also look into what risks it is currently facing. Case in point: We've spotted 1 warning sign for DEN Networks you should be aware of.

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. 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 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.