We're Not So Sure You Should Rely on Sandesh's (NSE:SANDESH) Statutory Earnings

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Sandesh (NSE:SANDESH).

It's good to see that over the last twelve months Sandesh made a profit of ₹741.2m on revenue of ₹2.98b. Below, you can see that both its revenue and its profit have fallen over the last three years.

Check out our latest analysis for Sandesh

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. So today we'll look at what Sandesh's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sandesh.

Examining Cashflow Against Sandesh's 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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2020, Sandesh recorded an accrual ratio of 0.42. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of ₹1.5b, in contrast to the aforementioned profit of ₹741.2m. We saw that FCF was ₹322m a year ago though, so Sandesh has at least been able to generate positive FCF in the past.

Our Take On Sandesh's Profit Performance

As we discussed above, we think Sandesh's 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 Sandesh's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 10% in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Every company has risks, and we've spotted 3 warning signs for Sandesh (of which 2 are a bit unpleasant!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Sandesh's profit. 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 that insiders are buying.

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This article by Simply Wall St is general in nature. 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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