Aarti Drugs' (NSE:AARTIDRUGS) Anemic Earnings Might Be Worse Than You Think

The subdued market reaction suggests that Aarti Drugs Limited's (NSE:AARTIDRUGS) recent earnings didn't contain any surprises. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

Check out our latest analysis for Aarti Drugs

Examining Cashflow Against Aarti Drugs' 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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, Aarti Drugs recorded an accrual ratio of 0.21. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of ₹823m, in contrast to the aforementioned profit of ₹2.05b. It's worth noting that Aarti Drugs generated positive FCF of ₹667m a year ago, so at least they've done it in the past.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Aarti Drugs' Profit Performance

Aarti Drugs didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Aarti Drugs' statutory profits are better than its underlying earnings power. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 5 warning signs for Aarti Drugs (of which 2 can't be ignored!) you should know about.

Today we've zoomed in on a single data point to better understand the nature of Aarti Drugs' profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.