We Don’t Think Vertoz's (NSE:VERTOZ) Earnings Should Make Shareholders Too Comfortable

Vertoz Limited's (NSE:VERTOZ) stock performed strongly after the recent earnings report. However, we think that investors should be cautious when interpreting the profit numbers.

View our latest analysis for Vertoz

A Closer Look At Vertoz's 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. 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. 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, Vertoz recorded an accrual ratio of 0.37. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of ₹157.8m, a look at free cash flow indicates it actually burnt through ₹335m in the last year. We also note that Vertoz's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹335m. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

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

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Vertoz increased the number of shares on issue by 251% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Vertoz's EPS by clicking here.

A Look At The Impact Of Vertoz's Dilution On Its Earnings Per Share (EPS)

Vertoz has improved its profit over the last three years, with an annualized gain of 93% in that time. In comparison, earnings per share only gained 47% over the same period. And the 43% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 8.9% over the same period. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Vertoz shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Vertoz's Profit Performance

In conclusion, Vertoz has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. For the reasons mentioned above, we think that a perfunctory glance at Vertoz's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Vertoz as a business, it's important to be aware of any risks it's facing. In terms of investment risks, we've identified 2 warning signs with Vertoz, and understanding these bad boys should be part of your investment process.

Our examination of Vertoz has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 with high insider ownership.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com