We Believe That MIC Electronics' (NSE:MICEL) Weak Earnings Are A Good Indicator Of Underlying Profitability

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

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Zooming In On MIC Electronics' 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

For the year to March 2025, MIC Electronics had an accrual ratio of 0.43. As a general rule, that bodes poorly for future profitability. 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 ₹730m, in contrast to the aforementioned profit of ₹98.3m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹730m, this year, indicates high risk. 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 MIC Electronics.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, MIC Electronics increased the number of shares on issue by 8.8% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. 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. Check out MIC Electronics' historical EPS growth by clicking on this link.

How Is Dilution Impacting MIC Electronics' Earnings Per Share (EPS)?

As you can see above, MIC Electronics has been growing its net income over the last few years, with an annualized gain of 232% over three years. In comparison, earnings per share only gained 188% over the same period. Net income was down 84% over the last twelve months. But the EPS result was even worse, with the company recording a decline of 86%. So you can see that the dilution has had a bit of an impact on shareholders.

If MIC Electronics' EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. 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 MIC Electronics' Profit Performance

In conclusion, MIC Electronics 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 MIC Electronics' statutory profits might make it look better than it really is on an underlying level. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that MIC Electronics is showing 2 warning signs in our investment analysis and 1 of those is a bit concerning...

Our examination of MIC Electronics 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 is always more to discover if you are capable of focussing your mind on minutiae. 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.