Additional Considerations Required While Assessing Solex Energy's (NSE:SOLEX) Strong Earnings

Despite announcing strong earnings, Solex Energy Limited's (NSE:SOLEX) stock was sluggish. We did some digging and found some worrying underlying problems.

See our latest analysis for Solex Energy

A Closer Look At Solex Energy'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Solex Energy has an accrual ratio of 0.46 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. Even though it reported a profit of ₹210.4m, a look at free cash flow indicates it actually burnt through ₹535m in the last year. We also note that Solex Energy's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹535m.

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

Our Take On Solex Energy's Profit Performance

As we discussed above, we think Solex Energy's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Solex Energy's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that Solex Energy is showing 3 warning signs in our investment analysis and 2 of those are potentially serious...

Today we've zoomed in on a single data point to better understand the nature of Solex Energy's profit. 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. 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.