Thangamayil Jewellery's (NSE:THANGAMAYL) Earnings Quality Is Low

Shareholders didn't appear too concerned by Thangamayil Jewellery Limited's (NSE:THANGAMAYL) weak earnings. We did some digging, and we believe that investors are missing some worrying factors underlying the profit figures.

Our free stock report includes 4 warning signs investors should be aware of before investing in Thangamayil Jewellery. Read for free now.

Zooming In On Thangamayil Jewellery'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). 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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".

Thangamayil Jewellery has an accrual ratio of 0.46 for the year to March 2025. 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. Even though it reported a profit of ₹1.19b, a look at free cash flow indicates it actually burnt through ₹4.8b in the last year. We saw that FCF was ₹2.9b a year ago though, so Thangamayil Jewellery has at least been able to generate positive FCF in the past. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings. The good news for shareholders is that Thangamayil Jewellery's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Thangamayil Jewellery increased the number of shares on issue by 13% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a chart of Thangamayil Jewellery's EPS by clicking here.

How Is Dilution Impacting Thangamayil Jewellery's Earnings Per Share (EPS)?

As you can see above, Thangamayil Jewellery has been growing its net income over the last few years, with an annualized gain of 208% over three years. Net profit actually dropped by 3.7% in the last year. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 6.5%. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if Thangamayil Jewellery's earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Thangamayil Jewellery's Profit Performance

In conclusion, Thangamayil Jewellery has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means that shareholders now own a smaller proportion of the company (assuming they maintained the same number of shares). For the reasons mentioned above, we think that a perfunctory glance at Thangamayil Jewellery's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Thangamayil Jewellery as a business, it's important to be aware of any risks it's facing. For example, we've found that Thangamayil Jewellery has 4 warning signs (3 are potentially serious!) that deserve your attention before going any further with your analysis.

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.