Why Black Box's (NSE:BBOX) Shaky Earnings Are Just The Beginning Of Its Problems

Investors weren't pleased with the recent soft earnings report from Black Box Limited (NSE:BBOX). Our analysis suggests that while the headline numbers were soft, there are some positive factors which shareholders may have missed.

Our analysis indicates that BBOX is potentially overvalued!

A Closer Look At Black Box's 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.

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 September 2022, Black Box had an accrual ratio of 0.42. 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. In the last twelve months it actually had negative free cash flow, with an outflow of ₹943m despite its profit of ₹239.1m, mentioned above. We saw that FCF was ₹1.7b a year ago though, so Black Box has at least been able to generate positive FCF in the past. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

The Impact Of Unusual Items On Profit

Black Box's profit suffered from unusual items, which reduced profit by ₹379m in the last twelve months. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Black Box to produce a higher profit next year, all else being equal.

Our Take On Black Box's Profit Performance

In conclusion, Black Box's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Having considered these factors, we don't think Black Box's statutory profits give an overly harsh view of the business. So while earnings quality is important, it's equally important to consider the risks facing Black Box at this point in time. Case in point: We've spotted 4 warning signs for Black Box you should be mindful of and 2 of these are a bit unpleasant.

Our examination of Black Box has focussed on certain factors that can make its earnings look better than they are. 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 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.