Investors Shouldn't Be Too Comfortable With Saraswati Saree Depot's (NSE:SSDL) Earnings

Saraswati Saree Depot Limited (NSE:SSDL) announced strong profits, but the stock was stagnant. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

See our latest analysis for Saraswati Saree Depot

Zooming In On Saraswati Saree Depot's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Saraswati Saree Depot has an accrual ratio of 0.66 for the year to September 2024. 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 ₹395m, in contrast to the aforementioned profit of ₹331.3m. We saw that FCF was ₹124m a year ago though, so Saraswati Saree Depot has at least been able to generate positive FCF in the past.

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

Our Take On Saraswati Saree Depot's Profit Performance

As we discussed above, we think Saraswati Saree Depot'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 Saraswati Saree Depot's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 15% EPS growth in the last year. 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. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. To help with this, we've discovered 2 warning signs (1 is a bit concerning!) that you ought to be aware of before buying any shares in Saraswati Saree Depot.

This note has only looked at a single factor that sheds light on the nature of Saraswati Saree Depot'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. 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.

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

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.